On 27 April 2020, the House of Lords Finance Bill Sub-Committee released its report “Off-Payroll Working: Treating People Fairly” (“the Report”). Rebecca Sheldon summarises its findings below.
The Report was published following the Committee’s recent inquiry into the UK Government’s plan to extend the off-payroll working rules to the private sector. During that inquiry, the Committee was assisted by specialist advisers to the Committee, including Sarah Squires, a member of Old Square Tax Chambers. News of her appointment can be found here.
The off-payroll working rules are, in broad terms, intended to transfer responsibility for deciding if a worker is “inside” or “outside” IR35 to the end-client and if found to be “inside” IR35, will be treated as an employee of the client for tax purposes only. The Report considers the background to these rules, as well as broader issues around their potential impact on the labour market.
The Report begins with a summary of the Committee’s conclusions, highlighting that the “evidence we heard…suggests that the IR35 rules…have never worked satisfactorily, throughout the whole or their 20-year history.” Its main recommendation is that the Government should fundamentally rethink its approach to the legislation – and look to implement the recommendations of the Taylor Review of Modern Working Practices.
However, if the Government continues with its plans to introduce off-payroll working rules in the private sector from April 2021, the Sub-Committee said that it should first commission an independent review of these rules in the public sector to inform how to implement this change. At second reading of Finance Bill 2019-2021, the Financial Secretary to the Treasury said that such a review would now be commissioned.
Summary of findings
The Report is extensively researched and thorough and covers a lot of ground over its 65 pages.
The following summarises the Report’s main findings, Chapter by Chapter:
Chapter 1
Chapter 1 starts by outlining the reasons for the delay in implementing the new legislation (in short, Covid 19) and commenting that the delay gives time to re-think the legislation. It also notes that the Sub-Committee received more than 700 evidence submissions, with a “large amount of the written evidence” received coming from contractors themselves (some of that evidence is then summarised in Appendix 4) which, it says, demonstrates the strength of feeling of those affected by the changes.
Chapter 2
Chapter 2 sets out the background to the Finance Bill proposals, focussing on the changing patterns of employment which have resulted in increasing numbers of self-employed people and the growth in the use of personal service companies (“PSCs”). It concludes that trying to address the challenges posed by these changes goes well beyond the tax system, suggesting that addressing them only from a tax perspective is “unlikely to deliver the optimal solution.”
Chapter 2 also sets out a short history of IR35, concluding that the off-payroll rules are based on a flawed system, which has given rise to an “unacceptable” distinction between employment status for tax purposes and for employment law. It concludes by discussing the recommendations made by the Taylor Review in 2017, suggesting that the Government carry forward its work on this.
Chapter 3
Chapter 3 discusses the operation of the off-payroll rules in the public sector since 2017. It says that HMRC views the rules as having been a success, whilst many of those who gave evidence to the inquiry disagree (raising issues such as difficulty in applying the legislation, increased costs, and “blanket assessing” of some workers). The Chapter concludes by finding that the evidence received suggests that, in some parts of the public sector, the rules are not being applied properly, and expresses concern that there has been “no proper evaluation carried out” into the effect of the off payroll working rules. It therefore recommends that the Government undertakes an analysis of how the 2017 rules have impacted the labour market.
Chapter 4
Chapter 4 is focused on the specific measures that extend the off-payroll rules to the private sector and sets out the Committee’s specific findings about the proposed extension. It outlines the background to the rules including the various consultations before going on to discuss a number of problems with the basic IR35 test (which decides “deemed” employment) which is unchanged by the new rules. The Report highlights some of the difficulties in applying the IR35 test to determine employment reported by witnesses (some of whom questioned whether even HMRC has a full understanding of test given its success rate in IR35 challenges at tax tribunals)).
Issues with HMRC’s “Check Employment Status for Tax” tool (“CEST”) are also considered, including that in a “substantial minority” of cases it provides no determination (which in real terms was considered to represent around 35,000 PSCs). A key concern was that businesses and contractors have little faith in CEST, in part because they did not consider it properly reflected the case law. As a result, the Committee considered that the new rules would impose a heavy burden on businesses by requiring them to determine status using a complex, fact-specific test without a reliable tool to help them The Report questions whether CEST is fit for purpose.
The Report then refers to evidence that the potential costs to businesses of the new rules were significantly higher than HMRC had estimated (£14.4 million across all businesses), with the ICAEW reporting that £3 million had already been spent by six large businesses alone. There was then a discussion of the possible behavioural effects of the new rules. Concern had been expressed by witnesses that, to minimise their own risks, some clients had decided not to use freelance contractors at all whilst others appeared to be blanket assessing contractors as within IR35 (mirroring the blanket assessments in the public sector). Other witnesses had concerns about a possible growth of unregulated umbrella companies, with lower paid workers viewed as particularly at risk from them.
In terms of labour market impacts, the Report suggests that it was likely that the changes would cause disruption to the market. The Committee was concerned that the focus of HMRC, which was primarily in terms of increasing compliance, ignored the damage the change may cause to the diversity and flexibility of the market currently.
A discussion then follows of the three policy objectives of the proposed changes: compliance with existing legislation, protecting the tax base, and promoting fairness in tax treatment. The Report highlights the burden the rules place on businesses and the risk that some contractors will be wrongly categorised as inside IR35. It also raises a concern that by treating some contractors as employees for tax purposes but not for employment rights, the government is “replacing one unfairness with another.” Chapter 4 ends by stressing that the delay (as a result of Covid 19) provides an opportunity to give further consideration to the rules.
Chapter 5
Chapter 5 discusses possible alternatives to the off-payroll working rules, including a flat-rate withholding tax, a freelancer limited company, a levy on using contractors( or “engagers tax”), addressing the difference in NIC rates for the employed and self-employed or a statutory employment test. The Committee conclude by outlining that although each of these proposals would need to be developed in more detail, they could provide a less complex approach to the issues the off-payroll rules are meant to solve. It was recommended that, pending implementation of the Taylor Review recommendations, the Government implement one of these simpler, less burdensome alternatives to the off-payroll rules instead.
Chapter 6
Chapter 6, the final chapter of the Report, recommends that the Government design a short-term revenue raising measure that will not prove burdensome for businesses as they emerge from the Covid-19 pandemic, followed by a long-term alternative solution that should be certain, simple, fair, supportive of growth, administratively straightforward and enforceable.
The Appendices to the Report provide details of all the witnesses that gave evidence to the Committee and include a summary of some of the evidence given by individual contractors about how they were being affected by the proposed changes. There are also links to all the evidence seen by the Committee.
Impact of the report
The Report highlights the key problems with the original IR35 legislation as well as concerns about the off payroll working rules themselves. It strongly recommends that the Government use the delay caused by Covid 19 to consider reforms to this area of law. This Report will be welcome news to the many stakeholders who are concerned about the impact of the off-payroll rules being extended to the private sector. It is hoped that the Government takes the opportunity to engage with the Report’s findings seriously, although public statements to date show that the Government still plans to press ahead with introducing the off payroll working rules in April 2021.