The freelance dilemma

A dark cloud looms for contractors as the government edges towards reform of
controversial IR35 tax laws.

The issue is important enough to warrant the coalition government promising a
review of the law. However, it will not want to give too much ground on IR35,
enacted as it was to stop those masquer­ading as self-employed workers paying
less tax than those on permanent contracts.

But what are the options available to the government and what is likely to
Treasury ministers could scrap IR35 and consider each case on its merits. But
this would represent a huge risk because it could encourage tax avoidance.
Contract workers would exploit the lower rates of corporation tax compared to
income tax. They would then extract profits in the form of dividends, which
would see HMRC lose out on significant sums of income tax and national

The taxman could attempt to change the rules on the basis of proposals which
are being floated for the construction industry, called simplified status tests.

Advisers would back the application of these tests because they believe it’s
difficult to agree definitions with the taxman when a dispute arises. Advisers
believe HMRC takes the view a client is caught by IR35 until proven otherwise.

But the current tests to distinguish employment from self-employment income
for tax purposes are intricate, recognising the many different types of
relationship between company and freelancer, and the difficulties involved in
categorising borderline cases.

The tests therefore aim to reflect the true nature of engagements, not to
homogenise them. But this presents its own challenges, because even contractors
find it difficult to be clear on their working arrangements if they happen to be
working through an agency and don’t know what the deal is with the client.

This causes problems when a contractor has to convince the taxman the IR35
rules are not being flouted.

With all these factors considered, experts worry that the option of extending
the simplified status tests to all freelancers would be “catastrophic”. For
example, one of the tests treats a person as employed if they do not provide
their own tools. The limitations to this are obvious if you consider the
circumstances of a musician or crane driver.

A self-employed concert pianist does not take their grand piano to every
performance but uses one that is in the concert hall. A crane driver using
equipment onsite would be classed as employed under the status tests.

The second proposal would see freelancers classed as employed if they rely on
the company paying them to find a replacement when they are unable to work
because the taxman would treat it as evidence of a permanent contract.

The most likely course of action for the government would be finding some
middle ground by softening the existing IR35 rules.

It could achieve this by adding a statutory test of what constitutes self
employment in the IR35 rules, which would take each case on its individual

But given the importance of freelancers to the UK economy, advisers hope the
government doesn’t see this as a tax-raising opportunity to catch genuine
freelancers by expanding the IR35 net.

The Professional Contractors Group maintains IR35 makes very little money for
the government and given the cost of enforcing it, and the number of failed
investigations for HMRC, it may even cost more to implement than it brings in.

Neil Graham, principal at Berg Kaprow Lewis and a director of the
Professional Contractors Group, says: “Clearly any new legislation to replace
IR35 must include provisions to deal with artificial tax avoidance but small
businesses are at the heart of the UK’s economic recovery and those genuinely in
business on their own account should not be prevented from trading that way by a
piece of badly drafted legislation.”

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