Successive governments have failed to effectively ensure that the tax system has adapted to the changing world of work. But IR35 is just a sticking plaster over a larger problem and simply reviewing it in isolation is pointless, says Ray McCann.
A new prime minister, a new government, same old tax issues.
The loan charge has given added impetus to the long-running debate over how employees are taxed compared to the self-employed and the differences between the taxation of earned and unearned income, especially dividends.
These arguments put a renewed spotlight on IR35 and recently further fuel was added by former Chancellor Kwasi Kwarteng’s decision to repeal the 2017 and 2021 changes to IR35, only for his successor Jeremy Hunt to cancel the repeal within weeks.
IR35 is a sticking plaster over a much larger problem and simply reviewing IR35 in isolation is pointless. And it’s pointless for a straightforward reason – even with the changes in recent years to the taxation of dividends, any objective review of IR35 would most likely conclude that IR35 or something like it is needed to protect the tax base.
Significant Differential
Without the still significant differential in the overall tax and national insurance contributions (NIC) levied on the self-employed compared to the employed, we would not need IR35, personal service companies would not be as popular as they have become, and employers would not be able to exploit a part of the workforce through insistence on the use of zero hours contracts, job insecurity and the other ways in which the “gig economy” has grown.
Those within the scope of IR35 dispute this differential, and indeed the loan charge, pointing to the fact that they do not enjoy holiday pay, pensions, job security and the other benefits associated with being an employee. They also incur costs in maintaining any corporate structure. Some of this is recognised for tax purposes but why should the government give those who choose flexibility over holiday pay a lower tax burden or tolerate the use of corporate structures that achieve such an outcome?
Encouraging Entrepreneurship
The differential between the employed and the self-employed reflects long-term decisions made to encourage entrepreneurship in a very different time and it is almost 80 years since the decision was made to levy NIC only on employed workers. What is clear is that in the period since, such changes that have been made or proposed have been intended to narrow the differential but overall, the nettle has not been grasped. So is an individual providing contracting services through a personal service company acting in an entrepreneurial way? In my experience most businesses look to recover their costs (so far as they can through what they charge their customers or clients) and, since the status of a contractor is financially advantageous to the client, there should be some recognition of this cost saving in the level of reward paid, as compensation for these less generous contract arrangements, but this seems to rarely be the case.
Changing World Of Work
It remains difficult not to lay the responsibility at the door of government. Successive governments have failed to effectively ensure that the tax system has adapted to the changing world of work. Ask anyone to give you an example of a self-employed person, and they would probably say plumber, joiner, shopkeeper or hairdresser. It is unlikely they would say “contractor working through their own personal service company” and yet very many individuals operating in this way see themselves as precisely that. The government has known for decades that how people work and on what terms has been changing, yet it has been very slow to ensure that tax law kept pace. Employee benefit trusts (EBTs), loan schemes, and numerous other ways a lower tax charge has been achieved reflect a statutory code lacking the design capability able to ensure a clear and coherent tax position was maintained. Even something as straightforward as the time limit applying to the collection of NIC has remained unchanged over 20 years since the Treasury was first alerted to the fact millions are lost every year because HMRC does not understand the rules or apply them correctly.
Moving Forward
Few tax experts are prepared to defend the status quo, but moving forward with a coherent and workable approach requires us to look at the way services are provided. While some difference would likely be unavoidable, it remains the case that the tax and NIC paid are significantly affected by whether those services are provided through a sole trade or partnership or through a company. The starting point of any review should be that the same activities should attract the same tax and NIC liabilities, which obviously gives us the sticky issue of how to deal with dividends although coherence might bring about a reduction in the use of personal service companies.
It was interesting that the FA 2020 changes to IR35 (off-payroll working introduced in April 2021) saw many individuals being brought onto payroll. So, if a class of worker value flexibility, we must factor in some work-related outcomes of the pandemic such as the increase in working from home and the fact that many workers and employers see such flexibility as a key part of attracting and retaining talent. But we must also factor in that today we have a class of worker who is not traditionally self-employed but not traditionally employed either.
In 2000 the Revenue justified IR35 as intended to prevent the tax base from being undermined through lower tax and NIC, and individuals from being exploited by businesses forcing them into self-employed status with the loss of the employee benefits mentioned above. If those for whom the loan charge was a huge shock are to be believed, a fear of IR35 drove them into the clutches of the scheme promoters and whatever we do one thing is clear, the government cannot simply introduce more and more extreme measures to counteract the consequences of structural weaknesses in the tax code that should have been addressed very many years ago.