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KEY POINTS
- IR35 introduced in 2000.
- Tax advantages of being self-employed.
- Impact of employment law.
- Need for a statutory definition.
It is almost 30 years since I first became interested in the tax treatment of self-employed taxpayers. Two cases arrived on my desk at a time when I was in professional practice as a sole practitioner.
The first concerned an editor of a magazine who worked at a remote office more than 60 miles from the magazine’s office.
We were slightly fortunate to win the case, but the client did not appreciate the size of the professional fee, although this would have been far more had a local partnership or London firm acted for him.
The second case was much more complex and concerned the subcontractors of a company not within the building or construction trade who had been given poorly drafted contracts for services, which did not reflect the true nature of their work.
As more than 30 individuals were involved, this case turned into a long battle with HMRC that lasted six years. Eventually, I briefed counsel under the favourable arrangements offered to members of the Chartered Institute of Taxation.
When HMRC learned of this development and our intention to appeal to what was then the Special Commissioners they caved in. This time quite a substantial fee resulted. The client has since told me that he is writing a book about this whole saga.
In the intervening years there has been a quite extraordinary increase in the number of confrontations between taxpayers, their advisers and HMRC on this issue.
Some cases have been reported, as they have come before the Special Commissioners and now the First-tier Tribunal and the courts, but there must have been numerous cases heard by the former General Commissioners, or which were settled one way or another without going to appeal.
I do not propose to rehearse all the well-known cases in this article.
The curse of IR35
The whole situation has been exacerbated by the introduction of what is known as IR35 on 6 April 2000. This legislation was aimed at contractors who operated their self-employed activities through a limited company.
Large companies in particular were unwilling to subcontract to individuals unless they had such a company. This applied in particular to independent IT contractors.
Owners of such companies tended to withdraw money from their companies by means of dividends rather than salary and director’s fees. HMRC considered that there was a substantial loss to the Exchequer of PAYE tax and, more importantly, Class I National Insurance contributions.
Effectively, a sledgehammer was used to crack a nut by the complicated IR35 provisions.
The legislation has been neither popular nor successful, given that it is reported to have produced only £9.2 million in total in the tax years 2002/2003 to 2007/2008. It is currently under review by the coalition government, but it has already been announced that IR35 will not be completely abolished.
If the issue of self-employment and employment was important before IR35, the new rules opened the floodgates for controversy, protest and appeals. Numerous cases have gone to appeal, and some important cases have reached the upper courts.
There are websites advising contractors about IR35, and one tax consultancy (Accountax Solutions now part of the Abbey Tax Group) has operated successfully in advising on this issue and self-employment alone.
IR35 has also spawned numerous books, articles and conference sessions. A well-known book on the operation of IR35 was written by Anne Redston. Similarly Dave Smith wrote on IR35 Defence Strategies, which is an excellent resume of the issues and case and tribunal law. Professor Judith Freedman authored a learned treatise on self-employment and employment.
We are no nearer a solution to the problem of employment status, so what are the issues at stake?
Income tax
Attacks on self-employed taxpayers have been fuelled partly by HMRC jealousies. Some inspectors still consider that self-employed taxpayers are ‘getting away with something’.
Perhaps some inspectors should experience just how difficult it is to start and continue a small business in the 21st century.
An employed taxpayer pays tax and Class 1 National Insurance on earnings and may also be taxed on benefits. This is dealt with through the PAYE system, which is convenient for HMRC.
A self-employed taxpayer files annual accounts and tax computations, comes within self assessment, pays tax and class 4 National Insurance half-yearly and may also be registered for VAT.
Importantly, self-employed taxpayers may claim expenses ‘wholly and exclusively incurred for the purposes of the trade’. Most of these expenses are clearly business related.
More controversially, claims can be made for ‘dual purpose expenditure’ where part of the expenses is for private purposes.
In the accounts of a small business this could apply to motor expenses, telephone charges and a charge for using the home for business purposes. Payments may be made to the spouse or partner for assisting in the business.
This is in sharp contrast to employed taxpayers who can only claim for expenses ‘wholly, exclusively and necessarily incurred in connection with the employment’. It is this contrast that has fuelled the dislike by HMRC of small self-employed businesses. This is somewhat short-sighted, as past and current governments have always supported the inception and growth of small business.
Areas of conflict
Particular areas of conflict concern attacks by HMRC on self-employed status when a trader is carrying on a seemingly legitimate trading activity. Some of these cases have been well documented in tribunal and case decisions.
On the other hand, some employers have only engaged workers who are prepared to go self-employed, or have re-designated current employees. The lack of a statutory definition of self-employment has encouraged such initiatives, which in many cases deserve the attention of HMRC.
In the past few years, workers have been far more aware of the protection of employment law, which I shall now consider.
Employment law
For a self-employed worker the contract for services, whether written or implied, is likely to give the worker very few rights. Conversely a proper contract of employment should set out, among other items, holiday pay, employee benefits, pension arrangements and redundancy rights.
As business practice evolves, more and more workers have become aware of their rights. Some cases have come before the employment tribunals where the worker is already deemed self-employed for tax purposes, but where they are deemed employed for employment law purposes.
Lawyers and trade unions have, quite rightly, advised workers on their rights. See Anne Redston’s article ‘Bring on the substitute’ on page 8 for more on this issue.
This development has created confusion and has muddied the distinction between self-employment and employment even further. What can be done about this?
Statutory definition
Self-employment and employment undoubtedly continue to be a grey area. There is disquiet about the continuing anomalies of IR35.
On the other hand, many workers can only obtain work by going self-employed. HMRC inspectors continue to harass taxpayers when their view is that a taxpayer is not truly self-employed.
Is a statutory definition of self-employment and employment for both tax and employment purposes required?
The results would undoubtedly be arbitrary and there would be some winners and some losers. It would probably result in some appeals and cases going before the tribunals and courts.
Such a move would, however, dissipate some of the current confusion, unfairness and anomalies.
Currently it is still ‘open season’ for HMRC to target small sole traders and small company businesses and for unscrupulous employers to insist on self-employment when the worker is clearly employed.
