Can IR35 be fixed? 6 recommendations from the House of Lords

The House of Lords has issued a damaging report into IR35, with clear recommendations on how HMRC can fix the legislation.

It comes two years after its previous review, which was issued just before IR35 reform was originally meant to start in April 2020.

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IR35 news, nearly one year on

April is the first anniversary of IR35 reform being introduced in the private sector. The changes make it the client’s responsibility to work out a contractor’s employment status for tax (although the contractor will still determine their own employment status when working for smaller businesses). Read more about IR35 rules.

If a contractor is outside IR35, HMRC classes them as genuinely self-employed. But if a contractor is inside IR35, they’re treated the same as employees for tax.

Alongside the challenges brought on by Covid-19, IR35 reform made 2021 a rocky year for the self-employed.

Many of the concerns that contractors shared with us before the changes came in are now being repeated by the House of Lords.

So, here are six ways the House of Lords would fix IR35

Adjust HMRC’s IR35 tool

The House of Lords has been told that HMRC’s Check Employment Status for Tax (CEST) tool will continue to be unreliable if it doesn’t include mutuality of obligation (MOO).

MOO is part of employment case law that tests contracts to see whether a client is required to give a contractor work and whether the contractor is required to accept it.

If MOO doesn’t exist, it indicates the contract is outside IR35.

The House of Lords says that HMRC needs to clarify that CEST isn’t a ‘substitute for law’ and it should only be used for guidance. It also recommends that HMRC acknowledges that there are other tools that can legitimately be used to work out employment status.

The House of Lords also wants HMRC to modify CEST to include MOO properly.

The House of Lords says:

“The continued absence of questions on mutuality of obligation within CEST means that many of those impacted by the off-payroll working rules do not have confidence in the accuracy of its results.”

Address blanket assessments

The House of Lords suggests that HMRC gets tougher on companies that are making ‘blanket assessments’, that is assessing all the contractors they work with as inside IR35.

While companies can choose not to hire contractors as policy, making blanket assessments of contractors is non-compliant.

The House of Lords commends the fact that HMRC is taking a ‘light-touch’ approach to compliance in the first year. But the Lords’ letter recommends stricter action on companies effectively evading their responsibilities to contractors.

It also suggests that HMRC needs to ensure that businesses handle appeals properly when contractors question their status decision.

The House of Lords says:

“The Sub-Committee shares the concerns raised by witnesses about blanket assessment and the engager-led appeal mechanism. HMRC needs to take steps to address these problems through its compliance activity.”

Consider IR35’s impact on the UK economy

While HMRC is looking into the short-term effects of IR35 reform on contractor working, the House of Lords says that wider-ranging research is needed.

They believe that the overall impact on the UK’s economy and labour market needs to be looked into, as they’ve been told that it’s become much less flexible.

Last year, two fifths of contractors agreed that the UK would end up with a much less flexible workforce following the changes.

IR35 reform has also created much more pressure alongside challenges like EU withdrawal and Covid-19.

The House of Lords says:

“We are not convinced that the government is confronting the challenges that both businesses and workers face because of the new rules. The research to show the real impact of these rules should therefore be conducted expeditiously.”

Research the burden of costs on companies and contractors

The House of Lords notes that even though engagers should be absorbing the cost of employers’ National Insurance contributions (NICs), it’s being passed onto contractors in the form of lower rates.

IR35 reform was designed to make sure that employers pay their fair share of NICs, so the House of Lords believes the new rules are swapping one problem for another. So, it wants HMRC to reconsider the burden of costs issue.

The House of Lords says:

“One of the drivers behind the tax avoidance, which IR35 and the off-payroll rules were designed to address, was engagers’ desire to avoid paying employers’ NICs. Yet in practice it seems many engagers are still not accepting this responsibility, but passing it on to contractors via reduced rates of pay. It is lower paid contractors with the least bargaining power who are most disadvantaged.”

Regulate umbrella companies

The letter from the House of Lords highlights that while many umbrella companies fulfil a “useful function”, there are still concerns about “rogue umbrella companies associated with tax avoidance.”

We’ve previously reported on plans to regulate umbrella companies. The worry is that rogue umbrella companies will tempt lower-paid contractors, who’ve been hit hardest by IR35 reform, with unrealistic claims about the pay they’ll receive. The House of Lords feels this is one form of tax avoidance being replaced by another.

The House of Lords recognises that HMRC has focused on educating contractors about umbrella companies and that the tax body has launched a consultation on the role of umbrella companies in the labour market. However, they don’t feel HMRC has gone far enough.

The House of Lords says:

“We would have liked to see a greater focus on the protection of workers using the services of umbrella companies and a clearer indication of the Government’s intentions. The Sub-Committee feels that the Government has been slow to act against the harm caused by the activity of non-compliant umbrella companies.”

Consider tax status alongside wider employment rights

The House of Lords is concerned that while HMRC has tried to achieve fairness between people doing the same job, whether they’re an employee or contractor, it’s only looked at this in the context of taxes paid.

HMRC hasn’t considered whether contractors inside IR35 should get any rights that are also given to employees, as they are being treated as employees for tax.

The House of Lords wants to see HMRC implement the recommendations laid out in 2017’s Taylor review, which took an overall view of modern working practices.

The Taylor review said that tax law and employment law should be more closely aligned, with employment status not open to as much ambiguity as it is currently.

The House of Lords says:

“The mismatch between tax law and employment has resulted in a situation where individuals are treated as employees for tax purposes but without the rights which are normally associated with employment. In taking forward the off-payroll working reforms, the government has focused too narrowly on tax issues and not enough on wider issues of fairness.”

Do you agree with the recommendations from the House of Lords? Let us know about your experiences with IR35 in the comments below.

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