The OTS review IR35
The OTS has published its interim report reviewing small business tax simplification and IR35, making recommendations that threaten the tax advantages of contracting
Background to the review
The review of IR35 is part of a wider review looking at small business tax simplification by the Office of Tax Simplification (OTS) and ordered by the Chancellor. The OTS was established in July 2010, and is being run on an interim basis by former Conservative MP and Financial Secretary to the Treasury Michael Jack and former PwC tax expert and policy director of the Chartered Institute of Taxation John Whiting.
The Chancellor asked the OTS to 1) identify and provide evidence of the complexity and uncertainty created by IR35; 2) consider alternative legislative approaches that would be simpler and create certainty while ensuring that, where intermediaries are used to disguise employment, any income that is effectively employment income is taxed fairly; and 3) consider the scope for tax avoidance and the extent to which alternatives to IR35 would affect it.
Main recommendation
The integration of income tax and national insurance contributions (“NICs”)
The OTS concludes that for significant tax simplification to be achieved it would be necessary to make “major structural changes to the UK tax system”. The main recommendation falling out of the report is that income tax and national insurance contributions be merged into a single system. This would have knock on implications for IR35, which in the words of the OTS “should result in the IR35 legislation becoming obsolete”, as there are no longer tax implications for self employment.
Integrating income tax and national insurance contributions into a single system threatens to erode the advantages of contracting and will be strongly opposed by APSCo.
The report does acknowledge, however, that the process for making these changes is a lengthy one and therefore makes short term recommendations aimed at easing the burdens on small business, including around reform of IR35. Regardless of the highly undesirable implications of removing the tax advantages of contracting, a period of uncertainty while changes are made would be difficult for contractors and businesses to manage.
Recommendations on IR35
The report makes two main recommendations and some additional suggestions should the Government choose not to take these forward.
1. Suspend IR35, with a view to abolishing the legislation
The OTS asserts that in terms of achieving the goal of simplification of the tax system, its remit as a body, abolition of IR35 represents the “greatest improvement”.
How it would work:
- Suspension would take effect from a specified date, with the intention that in due course there would be permanent abolition.
- During suspension, there would be no new IR35 investigations.
In its analysis of a suspension of IR35 the OTS warns, however, that suspension would essentially condone the underpayment of Tax and National Insurance Contributions (NICs) by some individuals and would be seen as unfair by employees.
In terms of timing for suspension, the OTS recommends that it should be tied to the announcement of a timetable for assessing the integration of income tax and NICs. The OTS suggests that a timetable should be put in place by the Government by the end of this year.
2. Retain IR35 legislation, but improve administration and enforcement
The second recommendation involves retaining IR35, but improving administration processes. These changes would look to address the fear of investigation, the length of time of an investigation and allowing individuals to self certify their IR35 status with certainty. This would not need a legislative change and would be a short-term option while the Government considers the integration of income tax and NICs.
The OTS suggests the following changes:
Selection of cases
- introduce more consistent selection of cases for investigation and ensure that they are only dealt with by specialists;
- address the external belief that there is a link between tax/NIC yield identified/recovered and individual HMRC officers’ performance markings;
- eliminate the risk of investigation for those that have demonstrably taken reasonable care for example by conducting an IR35 review of contracts and working practices through a preferred supplier.
HMRC investigation process
- involve IR35 specialists at the outset (the fact finding stage) once IR35 has been identified as a potential issue by the compliance review/enquiry;
- set a maximum investigation timescale (say 12 months).
Reviews of investigations
- introduce an independent review process for current and future IR35 enquiries carried out by IR35 specialists.
- introduce an independent mediation service similar to the role of ACAS in employment tribunals (Alternative Dispute Resolution is possible). If there is still no agreement/settlement the case could go to a fast track service for an early tribunal hearing.
If the Government rejects the two previous options, the OTS suggests a further option for reform:
3. Create a “genuine business test” to exempt certain individuals
A third option would be to create an additional, “simple” test to determine whether or not a business should be within IR35. The OTS believes this test would reassure 90% of businesses that they are entirely exempt from IR35. The OTS states, however, that this option is “fraught with problems”, and could even increase the administrative burden of IR35.
How it would work:
- A ‘safe haven’ would be created for businesses to judge whether they meet the requirements of a simple test
- This test could be, for example, the number of customers a business has, or an assessment of a business’ salary costs as a proportion of expenditure.
- Any businesses passing the test could have total confidence that they would be excluded from IR35
