HMRC’s IR35 tool won’t stand up in court, claims leading tax expert

Contractors could find themselves burdened with tax hikes and diminishing opportunities thanks to the shortcomings of HMRC’s online IR35 testing tool, if the controversial public sector IR35 reforms go ahead next April 2017.

As part of its proposals, HMRC intends to release an online tool to help agencies and hirers determine the IR35 status of contractors. The taxman remains insistent that its tool will be able to replicate the outcome that case law judges would issue in court.

This is in spite of warnings from multiple experts that:

  • Its ambitions display a massive oversimplification of the relevant case law
  • Plans to release the tool within eight months are extremely unrealistic
  • If it were possible it would have been done by now
  • The result of the tool will not stand up in court

The last point is crucial, as senior manager of Tax and Business Law at the Association of Chartered Certified Accountants (ACCA) Jason Piper explains:

In many cases, for an IR35 tool to reach an incontestable judgement, it would effectively have to predict the future. There are too many barriers standing between HMRC achieving its goals with this tool, not least the underlying case law itself.

With the tool unable to provide agencies and hirers with the certainty required, contractors could suffer from diminishing limited company opportunities and tax hikes as a result of a shift in the supply chain landscape.

Why won’t HMRC’s IR35 tool hold up in court?

HMRC is so confident that in its consultation it claims it will be bound by the decision reached by its tool. However, as Piper explains:

  • This displays a huge misunderstanding of IR35 principles
  • It falls way short of being determinate evidence in a tax tribunal
  • Any result by the tool can be challenged in court

If anything that you could write down ahead of time, based on your prescriptive agreement, was good enough to take the contract outside of IR35, we wouldn’t have this problem.

If this was the case, everyone would be operating through IR35-proof contracts

says Piper, who points out that status is largely determined by the ongoing working relationship between contractor and client, which can often deviate from the written agreement. “What is written down before a contract begins won’t necessarily reflect what happens once the job starts. So it’s going to be impossible for the people conducting that analysis before the contract starts to definitely know what a contractor’s IR35 status will be.

IR35 ‘split case’ proves HMRC’s tool won’t work

A perfect case to demonstrate this would be the ‘split case’ ruling where IT contractor John Spencer’s company JLJ Services won a partial victory against HMRC in 2011:

  • Via his company, Spencer contracted for Allianz from 2000 to 2007
  • HMRC determined Spencer within IR35 and demanded £141,000 in unpaid tax
  • At tribunal, the judge determined that IR35 did not apply for the first three years of the contract, but did for the remaining four
  • The main factor was control, which was limited up until the end of 2003

“Say you were using the analysis tool on each occasion that Spencer’s contract was renewed. If the written terms of the contract hadn’t changed – which they hadn’t – at what point would you identify the flip between caught and not caught?” asks Piper.

He adds that, whilst the outcome of the online tool may be considered as part of the bigger picture by a judge at a tribunal, it can never be determinate simply on the basis that case law surrounding IR35 requires close examination of working practices.

How will clients and agencies be affected by the IR35 tool?

The shortcomings of HMRC’s tool are set to have disastrous effects for contractors and the whole supply chain as clients and agencies seek to reduce their own risk.

As Piper explains, the reforms essentially invert the process of IR35 checking. In the current IR35 format, HMRC targets arrangements where an intermediary is involved and investigates solely on the employment status aspects, meaning the process burden is focussed on areas of genuine IR35 risk.

The new proposals shift the onus onto the public sector client and agency, and will require them to carry out compliance procedures for every contractor that they engage, whether the factor ruling them out is the hypothetical employment status or the actual intermediary position. This creates an unmanageable process burden that HMRC’s IR35 tool is intended to mitigate by providing upfront certainty.

But if the tool won’t stand up in court, nobody is going to trust it, rendering it useless.

This excessive administration – along with the potential tax liability faced in the instance of a wrong IR35 judgement – means both public sector clients and agencies will look for ways to protect themselves, at the expense of the contractor.

How will contractors be affected by the IR35 tool?

There are ways around it for the engager,” explains Piper. “The likelihood is risk-averse public sector clients will attempt to de-risk their supply chain by engaging with companies that clearly aren’t intermediaries. The easiest way to do that is to engage with a huge plc.

This looks likely to become an attractive proposition for clients. Not only does it insulate the client from the administrative burden, it also means they can outsource all of their supply needs through one firm. This means only one check is required to prove the public body isn’t engaging with any intermediaries.

Unfortunately, contractors will bear the brunt of these changes with:

  • Diminishing opportunities with public sector clients
  • Potentially being forced onto the payroll, meaning reduced pay and increased tax
  • Reduced career development and flexibility
  • The potential end of limited company contracting in the public sector

What are public sector contractor’s options?

Piper notes that large agencies are going to be reluctant to trust a tool that can’t be relied on in court, and will seek to put things beyond doubt by taxing contractors as employees, rather than carrying out mass IR35 checks. At this point, contractors will have two options:

  1. Attempt to increase their rates to compensate for additional tax, circulating public sector money back to the Exchequer in the process
  2. Join the firm’s payroll as a fixed term employee, resulting in reduced income and a consequent decrease in Exchequer revenue

A recent survey by ContractorCalculator has found that four in five contractors would sooner leave the public sector than accept an inside-IR35 contract. However, Piper notes that contractors with skills specific to public sector services may have limited options otherwise.

He adds that the lack of freedom afforded by these potential arrangements flies in the face of contracting as a working arrangement:

There is no good way to do this that improves mobility and agility for the contracting community and, at best, contractors come out evens by upping their rate via a large agency or consultancy. At worst, they accept permanent roles and see their income decline. They’re also unlikely to get the same degree of development and flexibility in their career, which is what makes the UK contracting sector so valuable.

Help fight the public sector IR35 reform proposals

HMRC’s online tool won’t have any legal standing in court, but the IR35 reform proposals still pose a very real threat to contractors through the drastic knock-on effects highlighted.

The tool, like the proposed reforms as a whole, has been ill thought out and will prove unworkable in practice. If you’re a contractor, you still have time to help reject the reforms by raising awareness and highlighting this issue with your local MP now.

Published on: 24 August 2016 - By: Contractor Calculator

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