27th April 2020
Inquiry found rules to be “riddled with problems, unfairness and unintended consequences… the potential impact on the wider labour market has been overlooked by the government. A wholesale reform of IR35 is required.”
The report is critical of “numerous flaws” that “treats contractors as employees for tax purposes but do not qualify for employment rights, thus creating a class of zero-rights employees” and “places too great a burden on businesses”.
Summary of Lords Inquiry
It is right that everyone should pay their fair share of tax. But the evidence that we heard over the course of our inquiry suggests that the IR35 rules—the Government’s framework to tackle tax avoidance by those in ‘disguised employment’—have never worked satisfactorily, throughout the whole of their 20-year history. We therefore conclude that this framework is flawed.
Until the beginning of the COVID-19 pandemic, the Government had planned to extend off‑payroll working rules to the private sector in April 2020. The off‑payroll working rules build on IR35, and the new proposals were designed to mirror similar rules implemented in the public sector in 2017. Under the new rules IR35 itself will not change. Instead, large- and medium-sized businesses will be responsible for enforcing a regime which HMRC has struggled with.
The Government’s aim was to legislate for the new private sector rules in this year’s Finance Bill. But following the COVID-19 outbreak, and the Government’s assessment that introducing new rules was inappropriate at an extremely difficult time for the economy, the implementation of the rules will be deferred for a year.
We welcome this delay. It is right not to impose unnecessary burdens on business at such a difficult time. However, given the dysfunctionality of the existing system, we call on the Government to use the extra time to rethink fundamentally its approach to the legislation. We understand why, in order to improve compliance and protect the tax base, transferring responsibility for operating the rules to clients was deemed a remedy for the problems which have beset IR35. But the Government made this decision after considering the issue too narrowly, in terms of its tax take. It has severely underestimated the costs to business of implementing the changes. It did not take full account of concerns raised by stakeholders. And it did not analyse sufficiently the unintended behavioural consequences of the proposed reforms or their wider potential impact on the labour market, and on the gig economy in particular.
It is likely that the off‑payroll changes will cause widespread disruption. Many of our witnesses described how the proposals had already encouraged blanket status determinations and the early termination of contracts. We also heard that many contractors had been left in an undesirable ‘halfway house’: they do not enjoy the rights that come with employment, yet they are considered employees for tax purposes. In short, they are “zero-rights employees”. Separating employment status for tax purposes from employment status under employment law also fails to acknowledge that contractors bear all the risk for providing the workforce flexibility from which both parties benefit.
The Government should therefore take the opportunity afforded by the delay to analyse holistically the problems that we have uncovered. If the Government continues with its plan to introduce the off‑payroll reforms in April 2021, it should commission an independent review of the earlier introduction of the off‑payroll rules in the public sector to analyse how introducing off‑payroll rules to the private sector will affect the labour market. It should also, after two years of promising to do so, finally implement the recommendations of the Taylor Review of modern working practices: that the taxation of labour should be made more consistent across different forms of employment, while at the same time improving the rights and entitlements of self-employed people. We believe that the Taylor Review proposals offer the best long-term alternative solution to the off‑payroll rules, and provide an opportunity to consider tax, rights and risk together.
The UK economy is facing its most severe crisis since the Second World War. Even if the economy were to begin to recover in the next 12 months, the severity of the economic impact of COVID-19 is so great that it would be completely wrong for the Government to impose a new burden on business in the form of the existing off‑payroll proposals. However, business is likely to need considerably longer than a year to recover from the disruption caused by the COVID-19 pandemic. The Government should announce by October 2020 whether it will indeed implement the off‑payroll rules in April 2021, or whether any on-going impact to the economy resulting from the COVID-19 pandemic will require their implementation to be delayed further. In the longer term the Government should reassess the flawed IR35 framework, and give serious consideration to the fairer alternatives to the off‑payroll working rules which we lay out in this report.