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IR35 edging closer to ESI tool?

By Contractor Weekly

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OTS employment status report may provide ideas for IR35 improvement

Following the Autumn Statement announcement that the government will take forward the majority of the Office of Tax Simplification’s (OTS) recommendations contained in their review on employment status, David Gauke, Financial Secretary to the Treasury, has written to the OTS to confirm exactly which of those recommendations will be pursued.

It has been confirmed that 17 of the recommendations have been agreed by the government, with a further 6 to be considered.

Although IR35 was outside of the scope of the report, the OTS did suggest that the synergy between IR35 and the employment status review recommendations be explored. Whilst this was rejected, the government will consider the recommendations as part of the dialogue with business on improving the effectiveness of the intermediaries legislation.

The report found that the dividing line between employment and self-employment can differ depending on whether status is being decided for the purposes of employment law or tax. This therefore is a complicated situation which can cause confusion for both workers and employers. To help address this officials from HMRC, Treasury, DWP and the Department for Business, Innovation and Skills, have been asked to establish a Cross-Government Working Group for Employment Status. This group will consider the benefits of and barriers to an agreed set of employment status principles and a statutory employment status test.

Employment Status Indicator (ESI)

A number of recommendations were made in respect of the ESI tool as follows:

  1. Review and update case law underpinning the ESI tool.
  2. Maintain and improve ESI. Upgrade work should include:
    - More ‘real-life’ business examples.
    - More industry specific examples, which could appear depending on previous answers.
    - Some of the supporting guidance and help functions need to give clearer answers.
    - Improve software to prevent freezing.
  3. As part of the upgrade work, consider developing more than one version for different major industry sectors and who the main target of the tool should be, ie individuals, businesses or agents.
  4. Explore the possibility of making the ESI results definitive where the tool had been properly and reasonably completed.

All these recommendations have been accepted and HMRC are currently reviewing it to increase its use and provide greater certainty. Improvements are expected to be delivered by April 2016 with further work to be carried out through 2016/17. The department are also to consider whether they could stand by the ESI tool’s results if it has been properly and reasonably completed. This would mean that, where a business has acted reasonably, there is little risk of HMRC challenging the status of its workers.

ESI can be used by both individuals or engagers and, if developed properly, this could provide the improvement to IR35 that all are seeking.

Third way

This involves the introduction of a new category of worker, a 'third way' between the employed and self-employed, acknowledging that some workers do not fit easily into either of the two traditional positions and that they should be subject to a modified set of tax rules. Freelancers might fall into this 'third way' and who might be seen as people who have chosen this route of working and want certainty over their status.

However, this middle status would mean that those covered by it would have to accept the tax consequences that were part way between employed and self-employed. The Freelancer Limited Company idea, for instance, whereby the entity agrees to a fixed but fair salary: dividend split to ensure that some income is exposed to PAYE and NIC.

The OTS was not keen on this concept and the government shares their view.

Office holders

Although the OTS were keen that any distinction between the term ‘office holder’ and ‘employment’ in tax and NIC legislation should be abolished, the government rejected this on the basis that ‘office holder’ is a legislative term, which HMRC believes underpins important distinctions for tax and NIC.

Merging tax and NIC

As the OTS quite rightly make the point, unifying tax and NIC would remove many of the anomalies within the tax system and contribute significantly to simplifying issues around employment status by reducing the differentials. Unsurprisingly, the government have only chosen to consider this but governments have been doing that for decades now, so no change there!

Some other notable suggestions that have also been accepted by the government include:

  • Creating an employment status portal with all the government’s guidance on employment status, including both employment rights and tax.
  • HMRC should issue ‘best practice’ guidance for business on what to do when engaging a self-employed individual.
  • Set up an employment status helpline where businesses are able to discuss specific queries with an HMRC officer with specialist knowledge of the subject.
  • Consider allocating more resources to employment status and/or to ensure that more HMRC compliance staff receive training in this area.
  • Add more examples of common real life situation to HMRC employment status guidance.

It could be that one or several of these ideas will be assimilated into the IR35 solution so it will be interesting to see how this develops.

Published December 2015