Why IR35 must stay according to HMRC
Last week HMRC published its own figures to argue the case for the continuation of IR35, albeit that those figures may not be wholly reliable. This comes in response to the recommendations made in April of last year by the House of Lords Select Committee on Personal Service Companies (PSC’s), that the Revenue should provide reliable statistics that demonstrate the risk to the Exchequer that IR35 protects.
Although HMRC published an estimate of the cost to the Exchequer of abolishing IR35 in June 2014, this latest report expands on those figures to include an estimate of the administrative burden of IR35 on contractors. Unsurprisingly, the Government are firmly of the view that the administrative burden of IR35 is proportionate when set against the fiscal risk that the intermediaries legislation currently protects.
Cost of abolishing IR35
Direct costing
A total of 6,000 contractors indicated that they were caught by IR35 on form P35 in the year ended 5th April 2011. From this HMRC estimate that if IR35 did not exist then £30 million of tax would be at risk, based on the difference between the tax paid on salaries and the tax that would be payable if those freelancers paid themselves in a more tax efficient way.
Behavioural costing
Here, HMRC looked at the behaviour of both directors and employees.
The Revenue identified directors who reward themselves with dividends that represent 50% or more of their income and believe that 40% would change their behaviour if IR35 were not around, giving an approximate total of 220,000 directors.
In measuring the cost to the Exchequer HMRC took the difference between tax paid on income and tax that would be payable if contractors remunerated themselves that resulted in them paying less tax, if IR35 were to disappear.
When reviewing employees, HMRC once again turned to old data – salary levels in 2010/11. Assuming that 4% of all current employees would form their own limited companies if IR35 did not exist, this would give rise to 55,000 new directors.
The total behavioural Exchequer impact for 2010/11 comes to £520 million; £115 million for directors plus £405 million for employees. Add to this number the the direct Exchequer impact of £30 million and a grand total of £550 million is at stake
In arriving at these figures, HMRC did accept that there existed uncertainty relating to the salary levels at which individuals would consider incorporation and the number of directors that would adopt a different remuneration strategy in the absence of IR35.
Cost to business of IR35
This is expressed as the cost to contractors of disclosing information to HMRC or third parties and is measured as the additional burden caused solely by IR35. This includes the cost of a freelancers own time, professional fees and other items such as additional postage or tax software.
An analysis of company returns for 2011/12 gave rise to HMRC estimating that there are around 200,000 PSC with zero or one employees. Of these 75% engaged the services of an accountant to assist in providing IR35 advice. In calculating the average cost of the professional fees involved, HMRC used the hourly rate for chartered and certified accountants taken from a 2013 annual survey and uplifted this by 30%. The same rate was applied to a contractors’ time for the 25% of PSC’s that do not have an accountant.
The total cost to business in meeting their IR35 obligations is £15.8 million plus an additional £0.2 million in working out the deemed payment, giving an overall cost of £16 million.
The real cost however is likely to be far greater as in 2009 Oxford Economics estimated the average administrative cost to business as being £853. When multiplied by the 200,000 PSC’s this produces a massive £170 million.
Whilst it maybe that the true cost lies somewhere between the two sets of figures, this exercise is simply enforced window dressing and a means to attempt to justify an unwieldy piece of legislation that is unlikely to vanish in the near future or until such time that a suitable alternative deterrent can be found. You can hear the Revenue chants of IR35 lives, long live IR35!
HMRC estimates that the total cost of IR35 administration for the 200,000 PSC’s is £15.8m. So that’s £79 each.
Right.
And the several hundred pounds a year on IR35 insurance from QDOS and contract reviews just so we can have more certainty on what our tax bill is going to be is factored in where?
[quote name=”Alex”]HMRC estimates that the total cost of IR35 administration for the 200,000 PSC’s is £15.8m. So that’s £79 each.
Right.[/quote]
I have to agree with this.
Our business spends in the thousands a year ensuring that we are IR35 compliant. That is the direct financial cost that I can see leaving the business account.
There is also the un-quantifiable cost of the directors time that we spend on this as well.
Also need to account for costs of insurance against the risk of being caught in the IR35 trap. Plus costs of insurance to deal with HMRC enquiries.
But HMRC can’t have PAYE and corporation tax and VAT.
They lose corporation tax, VAT and personal tax income on dividends. This should be the true comparison, not just PAYE.
Fair enough, its needed to prevent disguised employment. But why does it have to be such a grey area that is based on incredibly vague factors?
They could make simple black and white rules, such as:
“a company director who has no other employees cannot base a dividend on income earned by their company for charging for their time only to a single client continuously for more than a year”
Then we would all no exactly where we stand.
[quote name=”Michelle”]But HMRC can’t have PAYE and corporation tax and VAT.
They lose corporation tax, VAT and personal tax income on dividends. This should be the true comparison, not just PAYE.[/quote]
The Vat element would remain with sufficient turnover but the loss of corp tax would be significant. The loss of personal tax on dividends would also be the same(ish) if all income was PAYE but the corp tax is a big hole in the IR logic.
I think at the end of the day (and I have been contracting 21 years now) if the IR had said Ok PSC’s. All income less expenses is PAYE. You pay employee NIC but NOT Employers too most PSC’s would have taken that. It’s the absurd fact they want 2 lots of NICs from essentially, and in most cases, one income source that isn’t fair. Employers pay NICs but they don’t pay their Employees NICs! When I was a kid that was called having your cake and eating it Mr IR! (I know it’s HMRC now!) At the same time if they also said, like MPs, you can claim your expenses for 5 years (LIKE MPs!!!!) instead of 2 then deduct them and then PAYE on the rest most PSCs would have gone with that. More expensive than current situation but not as unfair as IR35. I don’t think we would have seen the mass amounts of admin and litigation then either. We would then have a decent playing field to compete with the rip off merchants like IBM / PWC …. (Add 30 more) who raid government coffers with over priced consultancy fees on huge numbers of public sector failed projects in the essentially closed market to independent contractors.
IR 35 was a gift to the big consultancy houses who had lobbied for years to kill the independents off because we are cheaper and often better.
Only 6000 contractors caught by IR35? f it wasn’t so punitive PSCs wouldn’t have to go to such lengths to ensure they are outside this stupid land inequitable legislation. I cannot believe the revenue are so stupid not to see this.
The biggest success that HMRC have had with IR35 is in the creation of uncertainty. HMRC depend upon contractors being unable to know where they stand, having no clear case law which can be used as a reliable signpost, and erring on the side of caution.
One school of thought suggests that as IR35 is not a punishment (in that it does not tax you more than was due had to not thought that you were outside it in the first place) then why not take your chances? Being caught by IR35 only removes an advantage that the taxpayer thought he/she was entitled to but could not convince HMRC of. It would be sensible of course to keep the extra tax payable under IR35 aside until the risks of challenge have subsided. Tax payers caught by IR35 of often still better off financially than operating the same contract as an umbrella worker.
From the perspective of the tax loss to HMRC then what they actually stand to lose (and what they are trying to protect) is actually National Insurance. Dividends do not attract Employer’s or Employees NIC, but if dividends were taken as salary then NIC is payable. The interaction between corporation tax and personal taxes are largely designed to make sure the tax man gets the same overall taxes, even though it comes from different “pockets” of the Contractor. What he does lose, however, is the NIC.
[quote]They lose corporation tax, VAT and personal tax income on dividends. This should be the true comparison, not just PAYE.[/quote]
This is wrong – dividends are issues from profits which is *after* corp tax has been payed
[quote name=”Alex”]Fair enough, its needed to prevent disguised employment. But why does it have to be such a grey area that is based on incredibly vague factors?
They could make simple black and white rules, such as:
“a company director who has no other employees cannot base a dividend on income earned by their company for charging for their time only to a single client continuously for more than a year”
Then we would all no exactly where we stand.[/quote]
If we knew the rules we would play according to them and thus there would be fewer opportunities for penalties.