UK government considers shifting contractor tax compliance burden to end user

Requiring companies that engage contractors and freelancers to take on a "greater role" in the process is one of a number of options set out by HM Revenue and Customs (HMRC) in a 'discussion document' on the effectiveness of legislation designed to catch disguised employment, known as IR35. It is seeking views in order to "better understand the issues and explore options for reform", and would fully consult before implementing any changes, it said in the paper.

Employment taxation expert Chris Thomas of Pinsent Masons, the law firm behind Out-Law.com, said that it was "common practice" for businesses to take on consultants operating through personal service companies (PSCs) without "worrying whether or not they truly are self-employed".

"Moving the onus to employers clearly makes sense from HMRC's perspective given the difficulties of checking the engagements of multiple individual PSCs and the difficulty of recovering any tax which proves to be due – large corporates are obviously an easier target and this issue would doubtless appear prominently in employer compliance reviews."

"However, from the engager's perspective, the prospect of having to assess the status of all of their PSC contractors will be extremely unwelcome. Employment status is notoriously uncertain and, in practice, it seems likely that many larger corporates would opt for a conservative approach and apply PAYE where there is any significant doubt - or, in appropriate cases, look to engage individuals through intermediaries so as to shift the risk away from them," he said.

The IR35 anti-avoidance rules are designed to prevent contractors from incorporating as PSCs in order to avoid paying income tax and NICs. PSCs are typically limited companies through which an individual is contracted to supply services, but of which that individual is the owner and sole director. The individual would usually draw a dividend from the company, which would be taxed at a lower rate than income; or assign themselves a nominal salary. However, where IR35 applies, the contractor must pay broadly the same tax and NICs as an employee would.

HMRC said that there was a "growing body of evidence" suggesting significant non-compliance with the rules. In particular, it said that the number of people paying tax under IR35 had "remained fairly static" since the rules were first introduced in 2000, but that the number of PSCs in operation had increased "substantially". There were around 265,000 PSCs in 2012/13, an increase of 65,000 on the previous year; while noncompliance with IR35 is expected to cost the exchequer £430 million in lost revenue this year, according to the paper.

The discussion document asks whether assigning a greater role to the hiring party would be an effective way of clawing back some of this lost tax, and of levelling the playing field between those who are employed directly and those who would be employed directly if they were not operating through a PSC. It asks how it could be made "as straightforward as possible" for hirers to determine whether IR35 should apply as part of their routine hiring conversations, and whether there were any business sectors that would face particular challenges should the rules change.

HMRC said that there were "many legitimate, commercial reasons" for individuals to work through PSCs and for businesses to engage with them rather than hire employees. However, it said that the differences in tax treatment "contribute to, and reinforce, the incentives for individuals to work through companies when they would otherwise be employees, and for businesses to engage individuals through companies even if they are working in a similar way to their employees".

"It is this unfair manipulation of the rules that IR35 was introduced to address," it said in its discussion paper.

This initial consultation closes on 30 September, at which point the government will decide whether to proceed with reforming the rules. Any proposals would undergo a full consultation, HMRC said.