Ten reasons why IR35 will never work for small businesses

Dave Chaplin believes that IR35 will continue to strangle the flexible workforce if we let it. He has come up with ten truths that justify killing off IR35.

The best way to stimulate economic growth is for government to stop legislating and step aside, allowing businesses to embrace the benefits of the flexible workforce and contractors and freelancers the freedom to contract. HMRC is meddling in the legal system with IR35 and people should have the ‘freedom to contract’, the freedom to agree business terms and the contracts between themselves without interference.

HMRC, the Treasury or government needs the courage to recognise that the tax simply does not work and that it actually damages businesses, the flexible workforce and the UK’s international competitiveness. However, in reality IR35 won’t be abolished any time soon and the legislation will continue to act as a brake on the entrepreneurial activities of contractors and their clients.

Here are ten reasons why IR35 should be scrapped:

1. Solving a problem that no longer exists

IR35 was originally brought in to deal with the issue of ‘disguised employment’ that was common in the 1990s when permanent employees left the office on a Friday only to return to the same office in the same role as a contractor on Monday. This allowed employers to hang on to their skilled workers without the financial commitment of hiring an employee. In turn, the contractor could earn far more. This was rife in the IT industry but no longer happens now that the supply/demand dynamic has changed.

2. IR35 is unworkable

IR35 is a very complex tax law and only HMRC experts can apply it, of which there are only about 40 among HMRC’s 55,000 staff! Contractors exist in their thousands and have become increasingly savvy to ensure they avoid being caught by IR35.

3. Market forces make IR35 redundant

IR35 is designed to tackle ‘tax motivated incorporation’ and pinpoint those workers who operate through a limited company but in reality are employees and should be taxed as such.

However, contractors are paid much more than an employee and therefore pay more tax. HMRC cannot see this. The dividend tax changes that came into force recently claws back a significant amount of the tax differential between a contractor and an employee. This means that motivation to incorporate purely for tax purposes has been drastically reduced, making IR35 effectively redundant.

4. IR35 tax yield based on false assumptions

HMRC believes that the deterrent of IR35 generates £520 million in tax but in reality well paid employees do not set themselves up as limited companies because their employers simply don’t let them. It’s not because they are put off by IR35, and most are not even aware of the legislation.

5. The figures don’t make sense

HMRC is under the illusion that IR35 should raise an extra £430 million in tax. However, to achieve that sum would mean hunting down 145,000 contractors earning £150 a day inside IR35 every year or catching 65,000 contractors working full time on £500 a day.

But thousands of contractors have not been caught by HMRC because these ‘disguised’ employees don’t exist. HMRC admits itself that it does not have the resources to police IR35 and catch this many contractors, even if they are disguised employees. What’s more IR35 is too complicated for many inspectors.

6. End-hirers do not pay NICs

One big issue that is often overlooked is that a contractor pays the equivalent of employee income tax and employers’ National Insurance Contributions (NICs) through their own limited company. The end-hirer pays nothing if a contractor is caught inside IR35. Surely, if IR35 is going to be effective the end-hirer must take some responsibility as an employer and pay NICs as any employer would.

7. The UK tax system is anachronistic

The UK’s tax system is outdated. We have moved from an industrial age model of working to one that is geared around portfolio careers, gigging and freelancing which means we have seen a decline in employers’ NICs because freelancers do not pay this.

It also means that employers are paying less too as they are turning to skills on an as needs basis, keeping their organisations agile and turning to freelancers and contractors when it suits them.

That trend is growing with 1.9 freelancers working in the UK today. The tax system needs to recognise this shift and move with the times.

8. Brexit

On June 23rd the UK voted to leave the EU. Leaving the EU will bring a period of uncertainty and there are talks of Britain plummeting into recession.

However with change come opportunities for contractors. Leaving the EU is a massive one-off project that will impact on both the public and private sector. This is exactly the type of projects that contractors are best at and they can be relied on to help with the transition.

This is not the time to put the brake on and legislation can hinder and penalise a flexible group of workers who can help the UK through these uncertain times ahead.

9. A new digital tool is unworkable

HMRC is trying to achieve the unachievable in its bid to develop a comprehensive online IR35 test that provides a definitive result for contractors. It is part of its plans to reform IR35 in the public sector.

However it is a naïve attempt to achieve the impossible. Building a simple online tool can’t be done due to its inherent complexity. The finest legal minds haven’t been able to boil down decades of employment case law into an IR35 questionnaire that provides a binary result. The new test is doomed to fail.

10. Costs will rise

The Government is poised to reform IR35 for public sector engagements believing that HMRC is losing out on £400 million in tax annually from 20,000 contractors who work in the public sector.

It plans to move the onus of evaluating the workers IR35 tax status from the worker’s own company to the public sector body or agency / third party paying the company, who will be liable for collecting taxes using RTI. But the plan is flawed and government services will be decimated as 80 per cent of contractors will abandon the sector rather than accepting a contract outside IR35 and lose about 20 per cent of their income.

The Government will also lose out on £115 million in taxes and could face an increase of £610 million rise in costs per year for hiring the same workers on the payroll.

These were just three findings of a recent survey conducted amongst 500 contractors. The plan is ill-thought through, unworkable and unachievable.

In summary, no matter how often HMRC decides to review IR35 to devise more effective strategies for implementation, these truths confirm that the tax cannot ever work. It is a poorly thought through piece of legislation that was not fit for purpose when first announced, and it is designed to address a problem that no longer exists.

Dave Chaplin is CEO and founder of Contractor Calculator.

Further reading on accounts and tax

Ben Lobel

Ben Lobel

Ben Lobel was the editor of SmallBusiness.co.uk from 2010 to 2018. He specialises in writing for start-up and scale-up companies in the areas of finance, marketing and HR.

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