Table of contents
- 1. Off-payroll working rules (IR35) skip to link
- 2. House of Lords Economic Affairs Finance Bill Sub-Committee inquiry skip to link
- 3. ‘Off-Payroll Working: Treating People Fairly’ report skip to link
- 4. Recent developments skip to link
- 5. Read more skip to link
1. Off-payroll working rules (IR35)
In 2000, the Labour Government changed the law to ensure that workers who provide services to clients via an intermediary pay broadly the same tax and national insurance contributions as employees. This legislation is known as ‘IR35’, but is commonly referred to as the ‘off-payroll working rules’.
The intermediary is normally a limited company set up by the worker themselves and referred to as a ‘personal service company’, but it can also be a partnership or an individual. This arrangement sees the worker provide their services to a client through the intermediary, essentially as an off-payroll worker or ‘contractor’, rather than as an employee.
Providing services to a client through an intermediary can have several financial advantages. As explained in the House of Commons Library’s briefing on personal service companies and IR35, advantages include enabling the worker to pay themselves in dividends from their personal service company and therefore not being subject to national insurance contributions. Clients would also not incur employer national insurance contributions on payments made to a personal service company, nor would they be required to provide the worker with employment protection rights such as sick pay and working time protections.
The off-payroll working rules were introduced to ensure that intermediaries were not misused as a way of avoiding tax, according to a HM Revenue and Customs (HMRC) press release from 9 March 1999. This followed concerns in the 1990s that intermediaries were being used as a way of disguising workers as contractors when they were in effect working as their clients’ employees.
The off-payroll working rules remain in force to date. However, several reforms have been made since 2000. In April 2017, the Government reformed the off-payroll working rules in the public sector. This change meant that where a public authority engages a worker through an intermediary, the responsibility of deciding if off-payroll rules apply to that worker was transferred from the worker’s personal service company to the public authority. These changes were introduced by the Finance Act 2017.
Following this, the Government announced in the 2018 budget its intention to extend the 2017 public sector reforms to large and medium-sized organisations in the private sector from April 2020. The provisions to implement these private sector reforms were introduced in the Finance Act 2020. However, the reforms were temporarily put on hold following the onset of the Covid-19 pandemic and officially came into force on 6 April 2021.
2. House of Lords Economic Affairs Finance Bill Sub-Committee inquiry
Before the Finance Act 2020 came into force, the House of Lords Economic Affairs Committee appointed the Finance Bill Sub-Committee to consider technical issues of tax administration, clarification and simplification arising from the draft Finance Bill, published on 7 July 2019. The sub-committee’s inquiry focused on the provisions of the bill that would introduce off-payroll working rules to parts of the private sector. Its findings were published in the report ‘Off-Payroll Working: Treating People Fairly’ on 27 April 2020.
3. ‘Off-Payroll Working: Treating People Fairly’ report
The sub-committee’s report warned against extending the regime to the private sector before an assessment of the wider impact of the reforms to the labour market and economy had been undertaken.
The report stated that an increase in self-employment and personal service companies were evidence that there had been a “significant” shift in the operation of the UK labour market. It said the growth of the gig economy had been one factor that had increased self-employment, particularly for lower-paid workers. The phrase ‘gig economy’ has been used by the Government to describe the exchange of labour for money via digital platforms that match providers and customers on a short-term and payment-by-task basis.
The sub-committee said that the off-payroll working rules were based on the “flawed” IR35 system which separated employment status for tax purposes from employment status under employment law. It believed this separation was unacceptable because it failed to acknowledge that contractors were burdened with the risk of providing the workforce flexibility from which both parties benefited. Whilst the sub-committee supported the original IR35 aims of ensuring greater fairness in the tax system, it said the IR35 regime had been ineffective for some time and expressed concern that the Government had not found a better alternative.
The sub-committee questioned whether the ‘check employment status for tax’ (CEST) tool was fit for purpose. CEST is a free tool that businesses and individuals can use to determine whether a worker should be treated as employed or self-employed for tax purposes, and whether those working through intermediaries should be subject to the off-payroll working rules. As part of its evidence gathering, the sub-committee heard “significant” criticism about CEST from several contractors and businesses, including NHS Digital. The sub-committee’s report referred to a freedom of information release from HMRC that said CEST only provided an answer for around 80% of cases, with a “substantial minority” being undetermined.
Since the off-payroll working reforms were made in the public sector in 2017, the sub-committee said there was evidence that some organisations had not been applying the rules appropriately. For example, some parts of the public sector (including the NHS) were found to have made blanket status assessments. These blanket assessments had been used to determine the employment status of a group of contractors, rather than making a determination on an individual basis. This is against the off-payroll working rules that require each contractor’s case to be considered on its own facts. Additionally, the sub-committee said it had received evidence that blanket assessments were being replicated in the private sector, in anticipation of the April 2021 reforms. The sub-committee said there was a risk that workers would have been miscategorised and taxed incorrectly as a result of these blanket assessments.
The report said there was evidence of contractors deciding to leave the public sector workforce completely, with problems in recruitment and retention being seen as a result. Additionally, the sub-committee heard evidence that some large private sector businesses had been refusing to engage with freelance contractors as a way of “side-stepping” the off-payroll rules.
The sub-committee believed the off-payroll working rules were unfair because they treated contractors as employees for tax purposes, but did not entitle them to employment rights. It said this had effectively rendered contractors “zero-rights employees”. The sub-committee also believed the rules placed a heavy burden on businesses that had been given the responsibility to determine a contractor’s status under the off-payroll working rules. The report said that HMRC—which previously had the responsibility of determining whether the off-payroll working rules applied to contractors—had “struggled” to enforce the regime since its creation in 2000.
In response to the Covid-19 pandemic, the sub-committee welcomed the Government’s deferral of the extension of the off-payroll rules to the private sector from April 2020 to April 2021. It said the Government should use this delay to reconsider its approach to the legislation.
3.1 Sub-committee recommendations
The sub-committee made several recommendations in its report. In anticipation of the private sector reforms scheduled to come into force in April 2021, the sub-committee encouraged the Government to commission an independent review of the earlier introduction of the off-payroll rules to the public sector. The purpose of this would be to analyse how the extension to the private sector could affect the labour market. The sub-committee also called on HMRC to uncover the risks associated with engaging umbrella companies. Umbrella companies, according to HMRC guidance, are entities that employ temporary workers or contractors whose services they contract out to client organisations for a fee.
The sub-committee accused the Government of lacking strategic co-ordination when introducing the off-payroll rules reforms, having previously committed to implementing recommendations from the ‘Good Work: The Taylor Review of Modern Working Practices’ published in July 2017. This was an independent review commissioned by the Government that considered the implications of new forms of working on workers’ rights, responsibilities, freedoms and obligations. Recommendations from the Taylor review included the Government amending the employment status framework. It said a new ‘dependent contractor’ category should be developed that would cater for workers who were not employees, but who were also not genuinely self-employed. The review said workers that fall into this new category could be entitled to certain employment rights, but not be classified as employees. In the Government’s response to the Taylor review, it committed to addressing the employment status framework and said it would consult on the issue. The sub-committee expressed disappointment that the Government’s work on this issue appeared to have “stalled”, and recommended that the Government carry forward its work on the Taylor review.
Overall, the sub-committee said it believed that the Government’s main purpose of introducing the off-payroll reforms was to raise revenue. It stated the Government needed to reassess the off-payroll working rules framework and use the delay caused by the Covid-19 pandemic to consider “fairer and less risky” alternatives. In the short-term, it said the Government should design other less burdensome means of raising revenue. In the longer-term, the sub-committee believed an alternative solution should be created that was: simpler; fairer; administratively straightforward; enforceable; supportive of growth; and that gave all parties certainty about the tax treatment that applies to them.
3.2 Government response to the sub-committee’s report
The Government responded to the sub-committee’s report on off-payroll working rules on 26 June 2020. Amongst other things, it confirmed that it would implement the private sector off-payroll rules reforms on 6 April 2021 as planned. However, the Government agreed with the sub-committee that the delay caused by the pandemic should be used “productively and effectively”.
In response to the sub-committee’s request for an independent review to be carried out into the 2017 public sector reforms, the Government noted it had previously commissioned independent research that assessed the effect of the reforms on the labour market. The Government said researchers had found there was “no significant disruption to the sector or its use of contingent labour as a result of the off-payroll reforms”. However, the Government committed to commissioning further independent research into the long-term effects of the reforms on the public sector.
With reference to the sub-committee’s concerns about blanket assessments, the Government said evidence from the HM Treasury and HMRC review of changes to the off-payroll working rules found that the “vast majority” of businesses had processes in place to ensure accurate status assessments. However, the Government acknowledged the risks posed by blanket assessments and said HMRC would consider if any additional support could be offered to businesses. The Government also shared concerns about the potential growth of non-compliant umbrella companies. As a result, it had already acted upon the sub-committee’s recommendation for HMRC to engage more with businesses and tax bodies about the risks. The Government vowed to consider further action it could take to address this issue.
In response to the sub-committee’s recommendation that alternatives to the off-payroll rules should be considered, the Government said it had already looked at alternative options during previous consultations on reforms, and had set out its reasons for not pursuing such options following each consultation. The Government also said that “good progress” had been made with the Taylor review recommendations following the publication of the Government’s ‘Good Work Plan’ in December 2018. This plan set out a vision for the future of the UK labour market.
4. Recent developments
4.1 Sub-committee follow-up inquiry into off-payroll working
On 22 October 2021, the sub-committee launched a follow-up inquiry into off-payroll working. This focused on the impact of the reforms on the private sector and considered how the rules were working in practice.
Evidence sessions were held during December 2021, with the sub-committee’s main findings published in a letter to Lucy Frazer, Financial Secretary to the Treasury, on 9 February 2022. Key findings and recommendations included:
- The extension of off-payroll working rules to the private sector in April 2021 appeared to have resulted in an increased use of umbrella companies. The sub-committee said that there had been at least a fivefold increase in the number of individuals working through such companies over the last 15 years. Referring to data supplied by HMRC, it estimated that 500,000 individuals were working through umbrella companies by 2020–21, compared to 100,000 in 2007–08. The sub-committee expressed concern that this increase could lead to individuals, particularly those on lower incomes, becoming involved in rogue umbrella companies associated with tax avoidance. It noted that the Government had previously announced proposals for a single enforcement body to regulate umbrella companies. The sub-committee recommended that the Government commit to a date for bringing forward legislation to create an umbrella companies regulator.
- The external research commissioned by HMRC into the implementation and impact of the extension of the off-payroll rules in the private sector should be accelerated and made more comprehensive. This recommendation made reference to written evidence from HMRC in December 2021 that said it had commissioned research into the implementation and short-term effects of the private sector reforms. As part of the evidence, HMRC stated that fieldwork had begun but was not yet complete; however, findings would be published during 2022.
- A more coherent approach to employment status (that considers both tax and employment rights) should be taken by the Government. The sub-committee echoed its previous concerns that it was unfair to treat individuals as employees for tax purposes, but not for employment rights. It said the Government should press ahead with implementing the Taylor review proposals.
4.2 Government response to the follow-up inquiry
The Government responded to the follow-up inquiry via a letter to the chair of the sub-committee, Lord Bridges of Headley (Conservative), on 9 March 2022. It said that monitoring the impact of the off-payroll rules reform continued to be a priority for the Government.
On umbrella companies, the Government agreed that further investigation was needed. It said officials were working to build a detailed and up-to-date understanding of the market, and how it continues to evolve. This includes how umbrella companies can support a flexible labour market for end clients, employment businesses and workers. The Government said it had already taken steps to address umbrella company non-compliance, including bringing forward measures in the Finance Act 2021. Before deciding on future policy decisions in this area, it said it would consider industry and stakeholder feedback in the call for evidence on the umbrella company market, launched by HM Treasury in November 2021. It vowed to update the sub-committee once the evidence has been fully considered.
Referring to the sub-committee’s request for the external research into private sector reforms to be accelerated and made more comprehensive, the Government said the scope of the research was intended to make the most effective overall assessment of the impacts. It noted it would be challenging to change the research’s scope at this stage as the fieldwork was already under way. However, the Government emphasised that the research involved businesses with the most responsibility under the reforms, and would seek to identify any changes to how contractors are paid and engaged, as well as the process for making and handling disputes. The work would also be supplemented by other research into the supply chain. The Government agreed that the work should be conducted expeditiously, and advised that the findings would be published in 2022.
On employment status, the Government said that separate frameworks existed for determining employment status for tax and rights. However, it noted that several departments were considering how to address the employment status issue in the current context and would provide more detail in due course.
5. Read more
- HMRC, ‘April 2021 changes to off-payroll working for clients’, updated 6 April 2021
- IFF Research, Long-term Effects of the Off-Payroll Working Rules Reform for Public Sector Organisations, February 2022