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UK – Employment status clarity for contracts still a long way off

05 March 2015

Contractors face a long haul before any of the measures proposed by the Office of Tax Simplification’s (OTS) Employment Status Review to improve clarity on employment status can be evaluated and introduced. And that assumes any future government decides to act, according to contractorcalculator.co.uk.

The OTS Employment Status Review recommends measures that include the merger of income tax and National Insurance Contributions (NICs) and improving Her Majesty’s Revenue & Custom’s (HMRC) guidance and tools.

Somewhat worryingly, though, the OTS also recommends examining how a statutory employment test might work.

ContractorCalculator was one of the contributors to the evidence underpinning the report and company CEO Dave Chaplin was invited to give direct evidence face-to-face to the OTS team.

“This is a difficult area with no simple solutions,” stated OTS tax director John Whiting. “We identify both direct ways of simplifying things, such as streamlining definitions, and indirect ones, which would take the heat out of the issue. Some should be acted on in the short to medium term, others are promising routes to reform that warrant further work but which would mean major changes.”

As a result of its analysis, the OTS concluded that there has been a structural shift towards self-employment. However, the report also notes that there are no obvious quick and easy improvements that could be made to achieve a useful difference to the employment status situation.

Although the employment status review specifically excluded the intermediaries legislation (also known as IR35), the OTS highlighted that employment status case law is used to determine whether a limited company contractor is a ‘deemed employee’ for tax purposes.

As a result, the OTS acknowledged that: “Personal service companies (PSCs) may be affected by any outcomes from this review, if taken forward by the government.”

Dave Chaplin believes that, in a worst case scenario, it could mean limited company contractors potentially finding themselves the subject of a draconian statutory employment status test: “Whilst certainty will be of huge comfort to contractors, and a bonus compared to the current situation with IR35, it won’t be a benefit if greater numbers of contractors are misclassified into the ‘employment’ category. This could be the result of any statutory test.”

The OTS report states that: “Employment status is not determined by choice, it is determined by fact and law for the courts to decide.”

Mr Chaplin, however, disagrees: “Part of the problem causing uncertainty is that there is more tax yield to be gained from employees than from contractors and the self-employed. As a result, HMRC gets involved in what should be a decision made by the contractor and their client, and the taxman’s default position is that the worker is employed. If there is freedom to contract, employment status is not an issue.”

Mr Chaplin’s position is borne out by the report’s findings: “Evidence was taken from the OECD data which suggested that in countries where tax and NICs are more closely aligned there is a reduction in self-employment and the likelihood of people entering self-employment, and the duration of time people spend self-employed.”

“The various tables within the OECD data suggest the UK’s diminishing combined tax and social security rates, moving between employment to self-employment to incorporation, are not typical internationally.”

Of greatest concern is the OTS recommendation that there are grounds for a statutory employment test, suggesting that there are two approaches possible:

  • A detailed, complex exposition that would aim to reflect all relevant case law
  • A simple or pragmatic set of rules that would have rough edges.

Mr Chaplin’s concern is that many have tried to create such a test in the past and failed, pointing out that the report itself says: “Over the years, various tests have been proposed and many factors considered, but despite many attempts by the judiciary, there is no one single test.”

The report continues: “Our findings concluded no one country had adopted a full statutory test but many use a number of indicators (often built up from case law) to determine an individual’s status. There are, however, a number of examples of countries that have adopted quasi-statutory tests to determine atypical groups, including Australia (withholding tax), Italy, the USA (ABC test) and Ireland (withholding tax).”

“Where there are tests in place, they can be complex and can take a considerable amount of time to get agreement with the relevant authorities and establish employment status. One needs to consider if this is an effective method and would argue the case for a simple, easily managed system to be put in place within the UK with strict criteria that cannot easily be worked around.”

To which Mr Chaplin retorted: “So, if the UK’s finest legal minds have failed [to] develop a statutory test, and no other country with similar challenges has created an effective yet fair test, why does the OTS think that a statutory test would work this time?”

A simple short set of quantitative tests may be the only workable solution, but this could also equate to [a] draconian [system], dragging in too many contractors who are genuinely in business on their own account.

“The test would also need to replace IR35, so it is likely that enforcement will be very difficult,” Mr Chaplin continued. “But we know from experience that enforcement is already very difficult. There needs to be financial incentives for client firms to get it right, and a massive penalty for getting it wrong.”

“The cost of all of this enforcement and compliance work just because the tax rates are different is crazy. Surely this is another strong argument for merging income tax and NICs?”

The OTS has considered the concept of the freelancer limited company, saying: “We have also looked at the idea of a ‘third way’ – an intermediate status between employed and self-employed. Overall we are not recommending it as a way forward but we do not dismiss it and would welcome further input addressing some of the issues we highlight.”

Contracting sector experts are split over the issue. The Association of Independent Professionals and the Self-Employed (IPSE) CEO Chris Bryce is in favour: “Many industry experts have been calling for a freelancer limited company. We are glad the OTS recognises the potential of this idea and we agree that it needs to be developed further.”

In contrast Derek Kelly, Managing Director of Parasol and ClearSky Contractor Accounting parent group Optionis is “not hugely enthusiastic” about the idea, commenting: “For me, such a change could create more problems than it solves – as well as reinforcing the notion that personal service companies (PSCs) are somehow different to other businesses.”

The OTS agrees with Mr Kelly, saying: “If the freelancer limited company route is followed, then there is a risk we are straight back into IR35.”

“There is no simple solution to this issue. Part of the problem is that as the world of work has become more complex the lines have blurred between employees, workers and one-man businesses. There needs to be a holistic approach to the problem so that the choice as to which route an employer takes to engage an individual to perform a task is not driven by the fiscal consequences, but by the most appropriate route to get the work done” says Fiona Coombe, SIA Director, Legal and Regulatory Research.

To read the full report, click here.