IR35 edging towards a solution

ASK ANY contractor and he or she will tell you, the IR35 rules (so named for being the 35th press release from the 1999 Budget) are the tax equivalent of the proverbial sledgehammer cracking a nut.

Introduced to combat the huge sums of lost tax revenue brought about by the great wave of IT consultants working through personal service companies in the early 1990s, IR35 tries to impose employment taxation on arrangements using an intermediary to avoid PAYE and National Insurance (NI) charges.

A bit like those massive nets to catch tuna fish, that end up catching dolphins and turtles, opponents argue that IR35 has caused a great deal of bother for a great many people over the years; although it may catch those scurrilous tax avoiders, campaigners claims it can also affect genuine contractors, who may have been trading in a similar way for years before IR35 was ever dreamed of.

Furthermore, the responsibility for IR35 rests wholly with the individual contractor. While this may be considered appropriate for those seeking to minimise their own tax liabilities, where such arrangements are imposed on contractors by the employing company, as is often the case, anti IR35 figures argue this is unfair. Particularly, they say, when the contractor may not have even heard of IR35, much less understood the consequences of falling within the legislation.

Because the rules on the determination of a contract of service used in IR35 are so subjective in nature, there has naturally been considerable litigation on the subject. The latest of these cases was reported last week when Aircraft engineer Mark Fitzpatrick won his seven-year tax case and was found to be an independent contractor, not a quasi-employee.

The case turned on the ‘mutuality of obligation’ condition – in this specific case there were occasions where employees were required to remain on company premises but independent contractors, like Fitzpatrick, were not. The Tribunal decision was described as “a bloody nose for HMRC” (admittedly by the taxpayer’s adviser) and welcomed by freelancer representative group the Professional Contractors Group, who dismiss IR35 as “wasting taxpayers’ money in its application to freelancers.”

HMRC’s main gripe with IR35 type arrangements is that where someone is seeking to avoid, or reduce tax liabilities, introducing some kind of net to catch these avoiders is only reasonable on the part of the taxman. The downside is that they can spend seven years (and presumably huge sums of taxpayers’ money) chasing a tax case which is ultimately found against them.

There are numerous problems with IR35 as it stands; the fact that the legislation targets the intermediary company rather than the employer company, leaves it open to abuse by companies wishing to avoid the irritations of employer’s NI, statutory payments, holiday entitlement and employment law. Similarly, the rules may end up inadvertently catching genuinely self employed contractors who hadn’t the faintest notion of trying to avoid tax, leaving them facing an employee’s tax bill without the protection and benefits a genuine employment would afford.

The writing has long been on the wall for IR35, but the Government are loathe to remove the rules without a replacement regime in place-in their first Budget in June of last year, the coalition Government remained “committed” to reviewing IR35, and one of the initial tasks facing the new Office of Tax Simplification (OTS), under John Whiting (pictured) is to “explore alternative legislative approaches to IR35” as part of a review of small business taxation.

Indeed in a recent set of roadshows the OTS found that IR35 was one of the most frequent causes of complaint among tax advisers. Exchequer secretary David Gauke (pictured below) said in a speech this week that the government wanted “stability and certainty” in the tax system, but was “mindful” of the pressure tax revenues.

The initial findings of the OTS’ review are expected in time for the March Budget, and, in line with the Government’s strategy, we can, hopefully, expect some consultation on the new rules before they become law. But what are those new rules likely to entail?

Whatever new regime replaces IR35, there are likely to be both winners and losers. Almost certainly new rules will place some kind of obligation on the ‘employer’ business, possibly sharing both the responsibility and penalty for falling foul of the rules with the contractor’s intermediary company.

But the balancing act comes in when trying to ensure those not seeking to avoid income tax, national insurance or employment obligation are not (further) penalised. The genuinely self employed, as mentioned above, are some of those at risk, but the implications of some means of ‘forcing’ companies to employ contractors are wider reaching.

Given we could be on the brink of a double-dip recession, opponents question whether a tax policy that requires businesses to employ contractors as employees, or not at all, pushing them to choose the latter option? Shouldn’t tax law adapt to changing behaviours rather than changing behaviour in its application?

Mark Lee, chairman of the Tax Advice Network, said: “While we can reasonably expect the IR35 rules to be abolished, there will be new rules to prevent undue tax avoidance– watch out for Son of IR35″ And he may have a point. The old CIS subcontractor rules were not perfect, but perhaps IR35 is another case where many will conclude – better the devil you know.