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.

The government has confirmed it will proceed with the planned extension of off-payroll rules into the private sector from April.

The confirmation came in a report from Treasury published this morning into the review of the implementation of the extension off-payroll working rules into the private sector.

However, having listened to stakeholders the government also revealed it is making a number of changes to address concerns, and support the smooth and successful implementation of the reform.

These include:

• Customers will not face penalties for errors relating to off-payroll in the first year – barring cases of deliberate non-compliance 
• HMRC has reaffirmed that information resulting from changes to the rules will not be used to open new investigations into Personal Service Companies (PSCs) for tax years before 6 April 2020, unless there is reason to suspect fraud or criminal behaviour
• The government reaffirms the rules will only apply to services carried out from 6 April 2020 onwards
• The government will legally require clients to respond to a request for information about their size from the agency or worker, and update the legislation to address concerns raised over the rules as they apply to off-shore companies.

While HMRC has already published detailed guidance on the reform and clarified the position on a range of concerns raised – for example, the client-led status disagreement process, including by making explicit the time limits within which a disagreement can be raised – the Employment Status Manual guidance has been further updated in line with other outcomes from the review. 

Although HMRC has already published a factsheet to support contractors prepare for the changes, and are continuing to step up their communications in the run-up to implementation, it will launch further products to support contractors in understanding the changes, including a self-help guide on how to spot tax avoidance schemes.

Government further committed to continue to listen to stakeholders, and monitor and evaluate the operation of the rules, while HMRC is to commission external research into the impacts of the reform six months after implementation, including on how status assessments are being made.

Commenting on today’s development, Samantha Hurley, director of operations at APSCo and co-chair of the government’s IR35 Forum, said the association’s members will welcome the extra time to adjust that the promised ‘soft landing’ offers.  

“When the review into implementation was launched last month, APSCo made it very clear that we were not seeking a complete delay to implementation, but a period of time within which recruitment businesses and end clients wouldn’t be penalised. This was communicated directly to HMRC and other stakeholders, and we are extremely pleased this recommendation has been listened to and taken on board by the government.

“HMRC has long maintained that it genuinely wants businesses to comply with the new rules and that there will be no witch hunt – and this latest move suggests this may truly be the case. The fact that it has also published additional guidance to educate the supply chain is welcomed by APSCo.

“In addition, policy changes announced today also offer much needed clarity for our members. The fact that all businesses now have a statutory obligation to confirm whether or not they are ‘small’ takes the onus off others in the supply chain, while confirmation on the timeline for disputes is also welcomed. Many of our members will be particularly relieved that the rules will no longer apply to clients based wholly overseas, with the obligation to determine tax status in these instances moving back to the contractor.

“While there is no escaping the fact that the extension of off-payroll rules is not ideal, overall, this is a significant win for the professional recruitment sector and I’d like to thank all of our members who got involved, shared their experiences and contributed to this outcome.”

Sophie Wingfield, director of policy at the Recruitment & Employment Confederation, said: “It’s a positive move that the Treasury is putting the obligation on small businesses to declare whether the IR35 rules apply to them. This is a direct response to what the REC has been calling for and should provide recruitment businesses with much needed clarity on their obligations.”

In relation to the decision by HMRC to take a ‘light touch’ approach to enforcement, Wingfield added: “Taking a ‘light touch’ approach to enforcement in the first year will create more problems than it solves. The consequences of not complying with tax law should be clear. Not doing so could create an unlevel playing field where compliant employers lose out to unethical ones. We need to see more details about how this approach will work in practice. What’s obvious from this is that the Treasury know IR35 is not quite right. Rather than tinkering around the edges of this complex legislation, we need the government to delay implementation until 2021 to make sure it’s done properly.”

While welcoming government’s promise of a soft landing in implementation of the rules, Julia Kermode, CEO of the Freelancer & Contractor Services Association (FCSA), added she is cautious that this may cause more confusion if clients and contractors are misled into thinking that the legislation has been delayed or will not be enforced.
 
“We have confirmed with HMRC that the soft landing is genuine and that penalties won’t ordinarily be applied for the first 12 months of implementing the reforms. This is good news because HMRC’s education programme was delayed due to the general election, so a number of businesses are only finding out about the reforms and their new liabilities now, just weeks before the legislation comes into effect. However, the soft landing does not mean that businesses and individuals can plan to ignore the changes because HMRC has also confirmed that penalties will be applied where there is deliberate non-compliance.

“FCSA also welcomes the clarity regarding overseas clients being out of scope, plus the amendment requiring clients to confirm whether or not they are small so that the supply chain can ascertain if the new off-payroll rules apply.
 
“It has been clear to me for some time that HMRC has been hell bent on planning to implement the off-payroll reforms this April come what may, and the publication of their review clearly shows that these reforms are coming whether we like it or not. I can’t see the budget on 11 March bringing about a U-turn, so it would seem that the House of Lords inquiry into the legislation is the last hope to affect any meaningful change.
 
“Having given evidence to the House of Lords this week, it was clear that they were listening to the various representations, and I did get the distinct impression that they were not supportive of the legislation. Time will tell as to whether or not they can make a difference but, in the meantime, I would strongly urge everyone to prepare for the reforms as penalties will still be issued for deliberate non-compliance.”

Gradually throughout the year more and more companies have set the precedence for incoming IR35 reform by confirming that they will not be engaging with contractors regardless if they are considered outside IR35. Banks and financial companies alike all seem to be following suit.

For contractors working with RBS, Tesco Bank, Barclays, Lloyds and Morgan Stanley the future points towards being put onto the payroll before the reform is introduced on 6^th April 2020. The most likely outcome for contractors being put on the payroll through an umbrella company.

These companies are reportedly giving contractors no option but being paid via PAYE to avoid IR35 reform altogether. IR35 rules do not apply to contractors working through umbrella companies nor employees. Furthermore, HMRC will not dispute engagements in which independent workers are operating inside IR35.

This cautious strategy may not pay off however and could potentially pose a greater threat to private sector firms by scrapping all outside IR35 contractors. From where we’re sitting it may be a risk not worth taking, for the following reasons…

Potential skills shortage

Most contractors would prefer to continue working independently and outside IR35, so giving contractors an ultimatum to go PAYE or leave could mean private sector businesses risk losing their highly skilled, and sometimes irreplaceable, contractors if they decide to leave the contractors no choice.

From our work with over 100 businesses and recruitment agencies we have concluded that there could potentially be tens of thousands of opportunities for contractors wanting to carry on working outside IR35 like before. We are all unsure of how big of an impact the reform will really have but it may not be all doom and gloom for those wanting to maintain higher day-rates.

Significant cost implications

If the risk of losing your superior talent isn’t enough, shifting contractors onto the company payroll is a costly process, without even considering the overall costs of employment. If businesses opt for turning their genuine contractors into employees the cost of paying employer’s National Insurance Contributions is reason enough to re-think, especially for companies with hundreds/thousands of contractors. In addition to this, the various other expenses of employees run the total up higher than you think. Office and equipment costs, sick pay, holiday pay and paid maternity or paternity leave.

For hiring organisations who depend on keeping their finest contractors may often have no choice but to offer great employment contracts. Company cars and other employee benefits are often a way of making up for the money contractors will be losing out on.

In simple terms, although independent day-rates might seem more expensive to companies, a lot of the time hiring a contractor outside IR35 tends to be cheaper.

Administrative burden

With greater costs being taken into account and also the potential skills shortage, there is then the burden of putting thousands of contractors onto the payroll. Not only that but looking after these workers in line with an employer’s HR obligations.

While private sector firms might argue that assessing each and every contractor’s IR35 status is an intimidating job, in contrast to onboarding thousands of employees, it is at least a one-off task assuming that the details of the contractor’s engagement remain the same. 

Restricted business agility

The most valuable part of using contractors is the unrivalled flexibility they provide businesses. Private sector firms can engage contractors as and when they need them with not many strings attached. This is extremely helpful in handling fluctuations in demand. The ability for firms to scale their workforce to their will should not be underestimated and employing contractors in permanent positions will eliminate that benefit.

Only time will tell as to whether these financial services firms rethink their position. There is, however, at least one thing we are confident in: that IR35 reform is manageable and Qdos are engaging with many hiring organisations looking to ensure fair assessment of their workers.

Find out more about IR35 reform in the private sector