Out-Law News 2 min. read

HMRC: IR35 'disguised employment' tax provisions worth over £500m annually

Abolishing rules designed to ensure that contractors in 'disguised employment' pay their full share of employment taxes would cost the UK Treasury £550 million a year, according to HM Revenue and Customs (HMRC).

An estimated 4% of those currently earning above £50,000, or 55,000 individuals, are likely to take advantage of the loophole that would be created if the regime was abolished, according to a report by HMRC on the "administrative burden" of the IR35 anti-avoidance regime. An estimated 200,000 directors, or 40% of those to whom the rules currently apply, would also likely change their behaviour, according to the report.

HMRC said that compliance with the regime cost taxpayers an estimated £16m annually, against the £550m cost to the Treasury of abolishing it.

"The government remains firmly of the view that the administrative burden of IR35 is proportionate when considered against the fiscal risk to the Exchequer of those incorporating [as a personal service company] to disguise employment income," HMRC said in its report.

Responding to some of the criticisms about the scheme, HMRC said that it had done "significant work in recent years to improve the administration of IR35, in particular by working with stakeholders on the IR35 Forum".

The report was produced in response to last year's recommendation by a House of Lords select committee that HMRC publish a "detailed assessment" of the administrative burden of IR35 versus the value of the tax and national insurance contributions (NICs) that would be at risk if the rules were abolished.

First introduced in 2000, IR35 is intended to stop contractors from incorporating as a limited personal service company (PSC) in order to avoid paying tax and NICs. A PSC is typically a limited company through which the worker is contracted to supply services, but of which the contractor is the owner and sole director. They are typically used by suppliers of professional services such as IT, and in the oil and gas sector. Where IR35 applies, the contractor must pay broadly the same tax and NICs as an employee would.

In its report, HMRC split the cost of abolishing IR35 into two parts: the 'direct' cost to the Exchequer and the 'behavioural' costs. It estimated a £30m direct cost to the Exchequer of the difference between tax paid on salary taken from the company where IR35 applies and tax that would be payable if the individual adopted the most tax efficient remuneration strategy in the absence of IR35. It estimated that directors changing their behaviour in the absence of IR35 would cost £115m, while employees changing their behaviour would cost £405m.

Calculating the annual administrative cost of the rules at £16m, HMRC said that £15.8m of that figure was the costs to taxpayers of understanding the legislation and ascertaining whether it applied. The remainder was the cost to taxpayers of working out their liability.

However, the Association of Chartered Certified Accountants (ACCA) said that the £16m figure did not account for "the wider costs to other businesses in the chain of the IR35 compliance process".

"Agencies and end users will often face an administrative burden of replying to the taxpayer's requests, while the contractor themselves will often be in limbo until that information is forthcoming," said Jason Piper, ACCA's tax technical manager. "The wider costs of IR35 are beyond what HMRC has the remit or resources to reasonably investigate but it's clear that the policy making process needs to address that wider drag on the economy."

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