Freelancers' advisors balk at IR35 business test
Advisers to freelance company owners range from disappointed to distressed in their reactions to ‘improved’ IR35 guidance from Revenue & Customs, saying the taxman has missed an opportunity then made a bad situation worse.
Unveiled on its website last week, HMRC’s package (PDF) is broadly in line with the advisers’ expectations – it contains new guidelines on the legislation; on six new IR35 Scenarios (or Examples), and a ‘business entity’ test.
Test subjects, personal service company owners who take the test’s 12 questions, are provided with a three-tier risk banding system - low, medium or high risk (of HMRC deeming that they fall within IR35).
So no nasty surprises have emerged in terms of the overall guidance package, the advisors reassured. Indeed, the scenarios and parts of the guidance are being cautiously welcomed, with particular praise to HMRC for its doubling in the number of IR35 case studies.
Other tweaks to how HMRC administers IR35 are being mildly accepted too, such as the introduction of HMRC “specialists” on an IR35 helpline, and quicker case decision-making from better trained IR35 compliance teams.
Writing exclusively for Contractor UK, IR35 expert Kate Cottrell warns that three such teams will begin approaching contractors in the coming weeks. The specialist teams have been specifically established at HMRC to pursue taxpayers using the new IR35 processes.
“The Revenue is obviously keen to educate more about IR35 and to make things clearer with their approach,” Martin Hesketh of Brookson, an accountant specialising in freelance tax issues, said of HMRC’s total package.
“It is also keen to make the enquiry process more effective, more quickly. These are good aims”.
“[We also] welcome the new scenarios that HMRC have included in the document – these bring much greater detail to the guidance and provide more information about more realistic and relevant scenarios than have previously been provided”.
Freelance trade group PCG seems to agree, saying “better” guidance and scenarios, improved IR35 helpdesk resources and quicker turnaround times are “advances” in the freelance trade group’s fight against the rule.
But any further industry support for the Revenue’s package of IR35 reforms and simplifications, shaped by the IR35 Forum and ordered by chancellor George Osborne in Budget 2011, is hard to come by.
In fact, a long list of freelancing, recruitment, small business, tax, accounting and legal experts are lining up to take issue with the IR35 business entity test which, alongside the IR35 scenarios, is being trialled ahead of a consultation.
Among them is Contractor Essentials, a firm of limited company tax advisors: “In spite of the courts determining that employment status, and thereby IR35, are determined largely by the three key factors of Control, Mutuality of Obligation & Personal Service, HMRC has given almost no weight to any of these in their business entity tests.
“The only one that gets a mention is [the other important factor] substitution,” the firm said, “but then all of the weighting goes to proof of actual substitution when, in fact, the courts have stated that it is the right of substitution that matters, even if it is never used.”
Sounding a tad perplexed, the firm’s founder Elaine Hazelwood pointed out that, under HMRC’s scoring system, the right of substitution is given “a mere” 2 points – five times less than those ascribed for having an office. Less than 10 points is considered ‘high risk’.
“I may have drifted off in the past from reading case transcripts,” she said, “but I can't recall a judge ever referring to business premises determining employment status; perhaps there will now be a surge of interest in virtual offices.”
However Egos, a legal specialist, says that the 12 questions in the business entity test seek to establish is “ not whether or not you outside IR35,” but rather “ whether or not you can be accepted as being ‘IBOYOA’ – In Business On Your Own Account.”
In a guidance note to freelance contractors, the legal advisor reasoned: “If you are indeed IBOYOA, then you might think that IR35 should not apply to you – and that your situation is one that was never (ever) intended to be caught by IR35…
“We see some acknowledgement of this principle by HMRC on page 10 of its guidance (and repeated on page 14), [when] HMRC says: “If you prove to our satisfaction that you are outside IR35 or in the ‘low risk’ band, then we will close our IR35 review.”
What this boils down to, argues Egos consultant Roger Sinclair, is the taxman saying ‘if we start asking you about IR35, [and] if you can show a score of 20 or more on the business entity tests, then you can tell us to go away.
“We will accept that, for that reason alone, regardless of the contracts and the reality of your engagements, we will accept that for that reason alone, you are outside IR35; and so we will go away, and will not bother you again for another 3 years.’”
As a result, Mr Sinclair predicts that “many” freelance contractors will begin to invest “considerable efforts” to bring themselves into the “magic 20-plus zone – and “keep themselves in it.”
At the same time, and where contractors refuse such efforts, industry group the Freelancer and Contractor Services Association believes that the test will have the unwanted effect of pushing a “disproportionate number of businesses into the high risk category.”
“In so doing, [it] will prevent genuinely high-risk cases from being identified,” a FCSA spokesman argued. “An alternative scoring system, backed by a majority on the [IR35] Forum, was suggested but to date those suggestions have been rejected by HMRC.”
Chris Bryce, PCG chairman confirmed: “External [IR35 Forum] members challenged HMRC to amend the scoring of the tests, branding the distribution of points as unfair and not reflecting the realities of how businesses operate.”
Contractor Essentials says the Revenue’s new Client Risk test, ascribing 4 points for a positive answer, is proof that the realities of PSC working have indeed been lost.
“HMRC describe business risk as having bad debts of more than 10% in the previous 12 months,” explained Ms Hazelwood.
“I have advised many businesses over the last 25 years and I am happy to say that I haven't seen any with a bad debt record as serious as that.
“Actually, in the last few years we have heard sad reports of agencies going bust and contractors not being paid.
“In most of these circumstances contractors lost a month's income; provided they had worked for the remaining eleven months they still wouldn't get any credit from HMRC [under this IR35 test] because their debts wouldn't have reached 10% of turnover.”
Quite apart from HMRC’s knowledge or understanding of PSC working being to blame, the PCG suggests it is more an issue of the tax authority’s willingness.
“HMRC’s new guidance demonstrates their fundamental lack of courage and commitment to improve the operation of IR35,” reflected Mr Bryce, who is also an IR35 forum member.
“[PCG] feels that the questions, the scoring and the proposed use of the business entity tests are counter-productive and represent greater complexity rather than a simplification of IR35 that had been the government’s goal.”
Emerging after the latest IR35 Forum meeting yesterday, Mrs Cottrell said: “I too did not support the tests whilst responsible for the Office of Tax Simplification’s IR35 review report, seeing them not as any sort of tax simplification but as an additional layer of complexity for those affected by IR35. My view has not changed.”
The Bauer & Cottrell co-founder added: “Those [freelance contractors] that come out low-risk and have the evidence to prove it will benefit from the tests in the event that they are investigated for IR35 but only when they are investigated. The value of these tests, whatever the scoring levels, is extremely limited.
“For example, if you could stand up tomorrow and say that 95% of freelancers are now ‘low-risk’ it would make no difference whatsoever to the need for them to consider their IR35 status for each and every contract they undertake.”
In his summing up, also with the average PSC owner in mind, Mr Bryce said HMRC had “missed a real opportunity” to both clarify IR35 and introduce the model of a business test in a clear and fair way.
Mrs Cottrell preferred: “These tests are a minor part of the administration of IR35 and as the IR35 legislation has not changed, failure to put in place an easy business test, cannot be seen in my opinion as a missed opportunity as there was no opportunity”.