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My Lords, HMRC and Contractors

House of Lords Select Committee publish their findings on PSCs

After an unusually brief timetable which began in November of last year, the House of Lords Select Committee on Personal Service Companies, this week published its findings.

The report itself is not designed to be comprehensive but instead focuses on five main areas and contains 16 recommendations.

(1)  Use of PSCs, relevant legislation and recent trends

There has been a growing use of PSCs over recent decades, in particular within the IT and oil and gas industries where it is long-standing practice to engage contractors via their own limited companies. Other sectors, in both public and private, are also choosing to use PSCs to fulfil their labour requirements, such as interim managers. It is estimated that up to 16,000 interim managers in the UK are providing their services on a freelance basis.

Whilst the tax incentives for establishing a PSC maybe attractive there are many other reasons why contractors incorporate their businesses such as limited liability, flexibility and credibility.

End users are also very much responsible for the increase in the PSC population as a changing regulatory climate has caused many engagers to demand that they only deal with PSCs.

(2)  Continuing viability of IR35

The primary focus of the Committee’s investigation was on the use of PSCs and the associated tax consequences, such as HMRC’s interpretation of IR35 and the department’s ability to administer and monitor this awkward piece of legislation.

Whilst the Committee heard evidence that IR35 is not a significant issue for businesses and contractors (try being subjected to an IR35 enquiry!) the Committee acknowledged that the unwieldy rules place a great demand on freelancers’ time. It will come as no surprise that the legislation invokes considerable hostility from the contracting community.

A large criticism of the way in which IR35 is operated is its reliance on case law and defining the tax position on a contract-by-contract basis.

Suggestions that the onus for carrying out an IR35 assessment should be placed on end users was dismissed on the grounds that businesses would find the additional administrative pressure and liability as overly burdensome. Welcome to the club!

(3)  HMRC’s administration and effect of recent reforms

Given the falling number of IR35 investigations compared to the increasing numbers of PSCs, IR35’s effectiveness is more as a deterrent than a raiser of revenue. This is endorsed by HMRC’s estimate of £520 million as the Exchequer protection which is 17 times more than IR35 yields. The value of this protection is in danger however if freelancers believe that HMRC are not willing or able to properly target those that pose the most risk.

John Whiting, Tax Director of the Office of Tax Simplification, believes that IR35 was never designed to be used to full force, giving further credence to the deterrent factor.

The PCG called for compliance and enforcement activity not to be increased until such time that IR35 is made much more clear.

There was a general consensus that HMRC do not provide sufficient guidance to PSCs. The introduction of the Business Entity Tests (BET’s) and the IR35 Forum was seen as positive steps but more can be done.

Judith Freedman, Professor of Taxation and Law, whilst not giving her unequivocal support, referred the Committee to the Australian alternative to the BET’s. The government down under use a 80:20 test. If at least 20% of a contractors work derives from more than one client then they are safe. This is not a simple system however as the basic guidance extends to 64 pages which is greater than BET’s.

(4)  Implications for the lower paid

Evidence suggests that PSCs are being used in less well paid professions such as receptionists, office workers, credit controllers, healthcare workers, telephonists and cleaners.

The Committee are concerned therefore that individuals in lower paid work that are being channelled through PSCs, umbrella companies or agencies may not be fully aware of the levels of employment protection and benefits they are potentially surrendering to work in this way.

With regard to Umbrella companies, HMRC acknowledged that some umbrellas are abusing expenses dispensations. What are they doing to counter this?

(5)  Public Sector

The use of PSCs in the public sector typically fall into three categories:

  • Interim management appointments;
  • Time limited project roles, particularly for IT infrastructure development projects; and
  • Roles that have temporary or time limited grant funding

The needs of the public sector are similar to those in the private sector and for this reason there should be no blanket restriction placed on the public sector in using PSCs as this would not be beneficial to the delivery of public services.

Criticism was made of the Treasury review that spawned the rules for public sector appointees as it only considered central government and its arm’s length bodies and did not directly include local government, parts of the NHS and other parts of the public sector.

Implementation of the rules are not being applied consistently across government departments, with some following the Treasury’s guidance to the letter, some simply regarding all PSCs as being within IR35 and others simply ignoring it!

Borne out of the Committee’s findings are a number of recommendations which are considered in a separate article – IR35: Something Better Change.

By Andy Vessey

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