Tax - Revenue must look after subcontractors.

IR35 has been the most hotly debated of all the changes announced in the 1999 Budget; MPs are said to have received more letters on personal service companies than on hunting.

At each stage of the parliamentary process there has been significant and vocal opposition to the measures. At one point the NICs legislation was thrown out by the House of Lords along with the rest of the Welfare Reform and Pensions Bill. However, in last week’s debate on the tax rules, signs of IR35 burnout were evident. The legislation gives all those working through intermediaries a five per cent allowance to cover expenses which would not be deductible under the narrow rules for Schedule E. This five per cent has been widely criticised as being too low. One MP asked the minister to justify the percentage.

Paymaster General Dawn Primarolo responded that Revenue research indicated current costs amounted to two per cent, and the extra three per cent took account of the additional work required by IR35, with the balance being accounted for by government ‘generosity’.

The committee was then treated to the extraordinary spectacle of the opposition MP attacking the extra three per cent as unfounded. It was unclear if he was really trying to reduce the allowance to two per cent or casting around for another stick with which to hit the minister. If the latter, it had all the force of a wet leaf.

Some interesting points to emerge were those provided by the Revenue.

New research indicates 90,000 personal service companies are within the scope of IR35 – an increase on the 66,000 on which the original Regulatory Impact Assessments were based. Those worried they may be within IR35 can send their contracts to the Revenue. They will then receive a ruling as to whether the Revenue considers the contract to be within IR35, so the worker is a quasi-employee, or outside IR35, so he can continue to pay himself in the tax-efficient way beloved of many small businesses. There has been no little scepticism about this process.

The Revenue said ‘the role of the Revenue is to provide advice and guidance about the employment status resulting from a given set of circumstances, not to impose any particular status’. (Tax Bulletin February 2000).

Many believed inspectors have a natural bias towards classifying people as employed rather than self-employed, and thus as within IR35 rather than outside it. To the surprise of all within the committee room, Dawn Primarolo announced that of the 1,200 contracts sent in for review, 53% were within IR35, and 47% outside it.

This suggests a more even-handed process than tax advisers and clients expected and may encourage others to seek a Revenue view. She confirmed 93% of contracts submitted for clearance were returned within 28 days from receipt. Further information had been requested on five per cent with the remaining four per cent taking longer than the 28 days.

If all the remaining 88,800 one-person companies send in their contracts, these impressive turnaround figures may drop off a bit. Less welcome were artificial defences put up by the minister when attacked by Richard Ottaway MP on the subcontractor issue.

As I said in my article last month, there is no interaction between the tax regime for subcontractors and for personal services, which means many subcontractors will suffer a marginal tax rate of over 60%. Although the excess tax of around 18% will be recovered, this may take two years, and as Mr Ottaway pointed out, the subcontractors have to pay their mortgages in the meantime.

Although a commitment was made by the minister that the Revenue will look at this issue, it is vital this is done quickly. Subcontractors should be informed of the likely outcome as soon as possible, before they take irrevocable steps to dismantle their companies.