IR35 was introduced in 2000 to tackle disguised employment. The legislation required an analysis of all the circumstances of a contractor’s engagement and, if they were working as an employee rather than as a self-employed contractor, they were required to pay the same tax as an employee – despite their contract stating that everyone concerned intended that they were engaged as a self-employed contractor.
In April 2017, the government changed the way IR35 operated for those who supplied their services to public sector clients. The change basically meant that the status of the contractor was determined by the client rather than the contractor. If a client decides that IR35 applies to a contractor, tax has to be deducted at source by those paying the contractor.
If the decision on status is incorrect then the liability for the underpayment of tax would sit with the business that paid the contractor. The idea was that the client would take a risk-averse approach to determining status if they had to pay for mistakes. This would mean less tax leakage due to the perceived misuse of status and the application of IR35. The reality is that many contractors are receiving less take-home pay as they are paying the same tax as employees but are not receiving any of the protections an employee would enjoy.
HMRC is now consulting about whether to apply the same changes to the private sector, but says that the consultation is not about introducing new laws but about ensuring better compliance with existing laws so it can reduce a loss which has been estimated at £1.2bn a year by 2022/23 if it did nothing.
To support the extension of the new approach to the private sector, HMRC is pointing to the success in the public sector. This is hotly disputed, with lots of commentators pointing to significant problems with the approach taken in the public sector, mainly revolving around the difficulty of using HMRC’s status tool on its website and the general confusion of determining a contractor’s true status.
Arguably, the real problem that needs to be tackled is the definition of self employment.
The world of work has changed significantly since the leading case law was established. There is a different definition of self-employment from tax and employment law perspectives, which is a source of continual confusion. HMRC has lost a number of recent cases with regards to its application of IR35. If it is unable to correctly apply its own test, is it time for a serious overhaul so that it reflects modern working practices and is easier to apply by all concerned?
Unfortunately, this isn't something that the consultation can achieve but it is something that needs to be considered by the government urgently and would no doubt be welcomed by those working with contractors, those providing their services in the wider gig economy, and those that have to deal with IR35 on a daily basis.
This is the big lesson that needs to be learned from the changes in the public sector. The test to determine status is difficult to understand and apply in practice, and in the public sector it has led to blanket directions from procurement departments that all contractors had to be paid on payroll.
This caused uproar and, anecdotally, an exodus of contractors from the public sector. This direction was quickly changed, but there are a lot of problems in practice, including claims being brought against recruiters or users of contractors for unlawful deductions from wages because they are making deductions for tax and NI at source that the contractors say they are not liable for – because they believe they are self-employed. The government needs to learn from these mistakes before rolling out any changes to the private sector.
It will be interesting to see how the consultation plays out over the summer and what changes, if any, the government makes to the way IR35 is applied in the private sector.
Simon Whitehead is a partner at HRC Law