IR35 is unlikely to be abolished or replaced in the medium term and, until the broader tax system is reformed to make IR35 irrelevant, HMRC could apply its considerable expertise and resources to better targeting ‘disguised employees’ who are not true contractors.
A revised enforcement strategy based on more effective targeting could improve the overall quality and consistency of enforcement. That would provide genuine contractors with the tax certainty they require, and would secure HMRC the high profile and genuine victories it needs to drive effective self-compliance among the contracting community.
And the evidence clearly suggests HMRC needs to change its approach, because its current strategy is clearly failing. Many contractors in roles that are ‘disguised employment’ are evading the legislation, and genuine contractors are being unfairly targeted, as in the case of the recent IR35 tax tribunal victory by Mark Fitzpatrick over HMRC.
An alternate enforcement strategy
When managed and motivated effectively, HMRC has considerable expertise and resources, and its tenacious effectiveness in combating avoidance and evasion by offshore account holders is evidence of this.
An alternative IR35 enforcement strategy could include:
- A centralised expert IR35 taskforce: Applying the tests of employment as defined by employment law to contractors requires a level of expertise that cannot reasonably be expected from mainstream inspectors; that’s one reason why so many IR35 cases fail, because many are brought against contractors by inspectors who are not experts
- Hugely improved targeting: HMRC has an incredibly detailed and powerful database of taxpayers and their details – the envy of every marketing database owner. By applying some basic marketing targeting techniques and asking more probing questions on, for example, form P35, HMRC could mine its data to create a list of much better inside IR35 ‘prospects’
- Higher quality enforcement: Focusing on those most likely to be IR35 fails would not only provide quick wins for HMRC, but also rapidly spread the word that HMRC means business. The alternative would be to continue spending huge sums on borderline cases or on long, drawn-out cases on principle to prove a point of law, and many such cases are being lost anyway.
The original IR35 proposals in 1999 proposed a model that required self-certification using some form of external audit. In the short term, until wholesale tax reform occurs, this approach could save HMRC time and money, because a swath of contractors would be immediately discounted.
How to target ‘strong fails’
In the analysis in Part 3 of Contractor Calculator’s IR35 Solutions Series, it was shown that it is very difficult for HMRC to win borderline IR35 cases, particularly when the contractor is a highly skilled knowledge worker and, at that level, key IR35 factors such as control become irrelevant.
So, why target contractors in the borderline category? Why not take the easy route, forget for now that element of HMRC’s strategy that requires it to tackle cases that prove a point of law – they can be tackled later or not at all when IR35 is irrelevant – and deal only with cases that can be won by focusing on contractors who are ‘high fails’.
As word spreads of HMRC's victories against 'disguised employees' that choose to use contracting as a front for their personal tax avoidance strategies, the level of compliance and 'self-certification' across the sector is likely to increase
Contractor Calculator’s Online IR35 Test uses a series of questions that, after running the answers through a thoroughly tested algorithm, place a contractor on a ten-point scale. Those at the ‘high fail’ end of the scale are, typically, the Friday-to-Monday and ‘permtractor’ types. How hard would it be for HMRC to include 100% objective questions on a P35 that highlights these ‘high fails’?
Objective questions for the P35
It’s a numbers game that could rapidly turn into a target-rich environment for HMRC’s IR35 expert investigators. The following simple questions, all leading to a yes/no answer and completely objective, could turn a few million P35s into a manageable list of ten-thousand high probability targets:
- Is this person a service company?
- Is this person working for a previous employer?
- Has this person worked for the same client for more than 2 years?
- Is this person on a fixed price or daily/hourly rate?
- Has this person ever substituted (and paid for the substitute)?
- Is the contractual arrangement on-going, or fixed term?
- Is the termination arrangement immediate, 30 days, or longer?
- And so on.
A couple of hundred experts could turn the ten-thousand targets into a thousand cases, all with a high probability of an HMRC victory, and high yield return in recovered tax. HMRC could even afford to be generous and offer an amnesty, such as those offered to offshore account holders.
Why should contractors be targeted?
Genuine contractors should have nothing to fear from HMRC. If HMRC adopts a strategy similar to that proposed, genuine contractors will almost certainly find life less stressful and, for those without tax investigation insurance, less expensive.
As word spreads of HMRC’s victories against ‘disguised employees’ that choose to use contracting as a front for their personal tax avoidance strategies, the level of compliance and ‘self-certification’ across the sector is likely to increase.
And if issues of compliance, tax avoidance and ongoing attention from tax authorities become the exception, then contracting might become much better known for the benefits it brings to UK plc, which would be to the advantage of all the UK’s genuine contractors.