Contractors should prepare for a spotlight on taxes

Contractors should prepare for a spotlight on taxes

From:  

As far as contractors are concerned, the big news from the 2016 Autumn Statement was confirmation from Government that they will be pushing ahead with plans to change the way IR35 works in the public sector. IPSE, along with many other business groups, strongly opposed this measure and we were very disappointed by the decision to implement it. But it should not be considered in isolation.

The Autumn Statement also told us this Government is very concerned about the tax base, the staggering rise in incorporations, and the rapidly diversifying labour market. All of this tells us we can expect more policy changes over the next twelve months and beyond.

What are the changes to IR35 and who do they affect?

The underlying IR35 rules are not changing, but the responsibility for determining whether they apply will shift from the contractor to the public sector end client. So, in the public sector only, the hiring organisation will determine the IR35 status of an engagement. If it decides IR35 does apply, the contractor business will be taxed at source, through the electronic Real Time Information (RTI) system, exactly as if it were an employee. This change will be effective from April 2017.

For now, the changes will only affect those engaged by public sector clients. Public sector clients are defined as set out in the Freedom of Information Act. In other words, if the organisation has to respond to Freedom of Information requests, it is a public sector organisation for IR35 purposes. But most, in fact all, independent experts we have spoken to believe it won’t be long before the Government considers rolling out the measure across the private sector too.

Why does IPSE oppose the change?

Public sector bodies will take a risk averse approach. Confronted with the well documented complexities of IR35, they will be unable to determine whether it actually applies, and they will be unwilling to assess each engagement individually. Because they could become liable - should they fail to apply the rules correctly - they will feel compelled to apply IR35 to all their engagements, even where there may be clear evidence the engagement is not one of employment. Essentially the shift in liability will lead to over-compliance.

This will result in thousands of contractors being taxed incorrectly and unfairly. They will be taxed as if they are employees, yet they will receive none of the benefits, such as pension contributions, holiday pay, sick pay and unfair dismissal protection, enjoyed by employees.

IPSE carried out a survey to explore how contractors would react to this change. We found that over half would leave the public sector altogether and a further 40% would put up their rates to compensate for the additional tax bill.

We shared these findings with the Government, demonstrating that this measure, instead of raising revenue, would actually end up costing the Government more. We reasoned that expensive consultants from the “big four” consultancies would have to be drafted in to replace the departing contractors, while those contractors that remain would charge more.

Unfortunately the Government chose to ignore our warnings.

What about the online tool?

The Government’s solution to the complexity of IR35 is a new online tool which will enable hirers to make an accurate assessment of status. IPSE had expected to see a version of the tool before now but at the time of writing, it hasn’t appeared.

IPSE does not believe the tool will work. The rules around status, and IR35, are too complicated and open to interpretation. Applying them to real life engagements can only be done subjectively. Generic tools are unlikely to generate an accurate determination. But we shall have to wait and see if this tool will prove us wrong.

Are there wider implications from the Autumn Statement?

Yes. Modern day Autumn Statements (soon to be Autumn Budgets) have at their centre a report from the Office for Budget Responsibility (OBR). This year the OBR took the opportunity to highlight the drop in tax receipts and the Chancellor responded with this:

“Tax receipts have been lower than expected this year, causing the OBR to revise down projected revenues in future. Added to this is a structural effect of rapidly rising incorporation and self-employment, which further erodes revenues.”

Reading between the lines then, the Chancellor is effectively saying: all these people working independently means less tax for the Exchequer, and we need to do something about it. Oh, and we are especially worried about those that incorporate.

What do the figures tell us?

When looking over the OBR figures it quickly becomes clear why the Chancellor is alarmed. Between 2000 and 2014, growth in incorporations averaged 7% a year – much higher than the growth in employees or the self-employed. More recent data suggests the number grew by 25% between 2014 and 2015.

At this rate, say the OBR, the Exchequer will be worse off to the tune of £3.5bn by 2022, and that is entirely down to more and more people working via their own limited company. The gig economy and other forms of self-employment are a whole other issue, and one that Government is quickly trying to get on top of.

Of course there are counter arguments to this. What about the unique economic contribution made by independent professionals? What about the VAT that many of them collect and hand over to the Government (they will soon be handing over a few percentage points more too, once changes to the flat rate scheme are implemented)? What about the recently introduced tax on dividends?

These are all valid points and IPSE will continue to make them, but we have to listen as well as talk. The Government is telling us that incorporation is eroding the tax base and they have the figures to prove it. We need to respond to that.

What what happens next?

In 2017 there is going to be a huge focus on the way people are working and how the tax system deals with them. It seems Government has finally woken up to what we’ve been telling them for years, that the world of work is changing, fast, and the tax system at the moment isn’t keeping up.

There are now no fewer than seven reviews or inquiries into the changing world of work. IPSE will be responding to all of them and we can expect to see more policy changes ahead.

Is there an alternative to more IR35 changes?

Against the backdrop of rising incorporation and falling taxes, it is hardly surprising the Government chose to push ahead with the one measure they had which is designed to get more tax out of incorporated entities.

IR35 doesn’t work – on this we all agree – but the Government won’t let it go. Instead they have introduced a measure which tinkers around with it, but doesn’t remove any of its faults.

The Government should instead have shelved the public sector plan while it considered more viable options for tackling the eroding tax base and the incorporation phenomenon. IPSE’s Freelancer Limited Company (FLC) would have been a good place to start, and it still is.

The FLC is designed to provide a benign environment for freelancing to flourish, while at the same time protecting tax revenues. IR35 would not apply to the FLC, as businesses within the structure would have already demonstrated they are not disguising employment. Businesses should be able to choose FLC status – they must not be forced into it – and they would have to meet certain criteria in order to qualify to be an FLC.

For more information on the proposed FLC framework - www.ipse.co.uk/policy/freelancer-limited-company

One of the UK economy's greatest assets

The UK’s flexible labour market gives us a competitive advantage over neighbouring economies and attracts investment. It is crucial to our future success, especially as we leave the EU. The Government must therefore be careful not to introduce measures which might curtail the dynamism of the flexible labour market.

That’s why it’s so important the Government gets this right. Measures such as the changes to IR35 in the public sector, suggest we might be heading in the wrong direction.

The FLC is the type of radical idea the Government should be considering. At this time we must embrace the invaluable flexibility and innovation which the self-employed workforce contribute to the economy, while also ensuring tax revenues are not completely lost.

The changes to IR35 in the public sector are rooted in the past. We need to look to the future.