The 'IR35' rules to prevent the exploitation of personal service companies for tax avoidance were introduced in April 2000, following a long and contentious consultation exercise. This legislation remains unpopular among freelancers who use this corporate form to provide services. This note looks at debates as to the effectiveness of these rules and wider concerns about the use of employment intermediaries to avoid tax, before discussing recent developments as to their application in the public and private sector.Jump to full report >>
In April 2000 the Labour Government introduced new rules for the tax treatment of personal service companies in the light of concerns that this corporate form was being exploited to avoid tax.
Individuals working in a number of fields often provide their services to clients through a personal service company (PSC), rather than taking up employment with that client. The client pays the service company for the work they have done, without deducting income tax under PAYE or National Insurance contributions (NICs). There are several possible tax advantages to this type of arrangement. First, the range of expenses which the PSC may set against its taxable profits will be much wider than that allowed an employee to set against his taxable income. Second, there will be a cash-flow benefit in avoiding tax being deducted at source each month. Third, the individual may be in a position to receive dividends out of their service company, as an alternative to only being paid a salary, and this form of income would not be subject to NICs.
After a long and contentious consultation exercise, provisions were introduced in the Finance Act 2000 with effect from the 2000/01 tax year. The rules cover any engagement where: a worker provides services under a contract between a client and an intermediary; and, but for the presence of the intermediary, the income arising would have been treated as coming from an office or employment held by the worker under the existing rules used to determine the boundary between employment and self-employment income for tax purposes, if the individual had contracted directly with the client. In these cases, the intermediary is required to account for tax on this payment in just the same way as employee earnings (ie, charge income tax under PAYE and Class 1 NICs). This legislation governing intermediaries is often referred to as ‘IR35’, after the number of the Budget press notice which first announced this measure.
Although IR35 remained controversial in the decade after its introduction the Labour Government showed no interest in withdrawing it. In July 2010 the Coalition Government announced the newly-established the Office of Tax Simplification (OTS) would review small business taxation, and this would include exploring “alternative legislative approaches to IR35.” The OTS completed its report just before the 2011 Budget. It set out several options for reform, including a merger of income tax and NICs which would make IR35 obsolete. In the absence of major structural change the OTS suggested that IR35 might be suspended with a view to being abolished, or amended to exempt certain businesses, or retained but with certain changes in their application. In the 2011 Budget the Government announced that IR35 would be retained “as abolition would put substantial revenue at risk,” though its administration would be improved.
In 2012 there were concerns about the numbers of senior staff in the civil service being employed through a PSC. In May that year the then Chief Secretary to the Treasury, Danny Alexander, gave details of a review of these arrangements, and of changes to the way departments could appoint individuals ‘off payroll’. The Minister also announced a consultation – foreshadowed in the 2012 Budget – on amending IR35: in brief, anyone providing their services through a PSC who had been taken on with a senior, controlling role for their client would be taxed as an employee. In the Autumn Statement the Government announced it would not proceed with this proposal “because HMRC’s new approach to policing IR35, along with the measures introduced in the public sector this year, are sufficient to prevent the loss through disguised employment in this way.”
In in its first Budget following the 2015 General Election, the Conservative Government confirmed it would “engage with stakeholders this year on how to improve the effectiveness of existing intermediaries legislation.“ A discussion document was published later that month; responses were invited by the end of September 2015. On the matter of compliance, the paper noted, “in 2011/12 around 10,000 people paid tax under IR35, an estimated 10% of those who should have paid tax on at least part of the income their PSC receives under the legislation.”
One question raised in this document was whether the onus for determining whether IR35 applied or not should be placed on the client, rather than the PSC: “under such an arrangement, those who engage a worker through a PSC would need to consider whether or not IR35 applies (in the same way as they would need to consider whether a worker should be self-employed or actually be an employee), and, if so, deduct the correct amounts of income tax and NICs as they would for direct employees.” The paper also asked for views on whether the tests to determine if IR35 applies could be simplified, “such as requiring an engagement to last a certain minimum amount of time to be considered one of employment.”
In November 2015 there were reports that the Government was planning a change in these rules so that any contractor whose placement lasted more than a month would have to go onto the client’s payroll as their employee. However, despite expectations, the Government did not announce major reforms to the rules at this time.
Several other measures have been introduced to prevent this corporate form being used for avoid tax. First, in the 2014 Budget the Coalition Government confirmed proposals to tackle the use of offshore intermediaries to avoid tax, and to prevent agencies based in the UK using contrived contracts to disguise employment as self-employment. Second, in November 2015 the current Government announced that from April 2016 it would “restrict tax relief for travel and subsistence expenses for workers engaged through an employment intermediary” where the intermediaries legislation applied.
Finally, in the 2016 Budget Government proposed that from April 2017 public sector bodies would have new duty to ensure any contractors that they took on were complying with IR35. A consultation exercise was launched in May 2016, and in the 2016 Autumn Statement the Government confirmed it would proceed with this reform. As part of this consultation the Government ruled out introducing a similar duty on the private sector, or having a new test for applying IR35 based on the length of the contractor’s contract.
With the implementation of these new rules there has been considerable speculation that the Government would extend the new duty for contractors’ clients to the private sector.
The Autumn 2017 Budget announced that the Government would “carefully consult on how to tackle non-compliance in the private sector, drawing on the experience of the public sector reforms.” This consultation was launched on 18 May this year, and closed on 10 August. The consultation paper stated that extending the public sector reform to the private sector is the Government’s lead option, though it noted “public authorities faced challenges in implementing the reform and that this is a concern for businesses and individuals working in the private sector.” HMRC also published a short factsheet on the consultation, and an independent review it had commissioned on the impact of the public sector reforms on client organisations at this time.
In his Budget speech on 29 October the Chancellor Philip Hammond confirmed that the Government would proceed with this reform, but the new rules would come in from April 2020 and apply to large and medium-sized businesses only. In its response to the consultation, the Government states, “a further consultation on the detailed operation of the new rules will be published in the coming months. This consultation will inform the draft Finance Bill legislation, which is expected to be published in Summer 2019.” It underlines the point that “the new rules will be given effect from 6 April 2020.”
This paper discusses these developments; a second paper looks at the introduction of IR35 and its first years of operation.
 Inland Revenue Budget press notice IR35, Countering avoidance in the provision of personal services, 9 March 1999
 HM Treasury press notice 29/10 20 July 2010
 OTS, Small business tax review, March 2011 pp5-6. The debate over merging tax and NICs is discussed in: National Insurance contributions: an introduction, Commons Briefing paper CBP4517, 17 July 2017.
 op.cit. p8
 Autumn Statement, Cm 9362, November 2016 para 4.11. Provision to this effect is included in the Finance Act 2017 (specifically section 6 and Schedule 1).
 HM Treasury press notice, Government to consult on tax avoidance in the private sector, 18 May 2018. See also PQs 150081-2, 13 June 2018
 HMT/HMRC, Off-payroll working in the private sector: consultation document, May 2018 pp22
 HMRC, Factsheet: off-payroll working in the private sector, May 2018
 HMT/HMRC, Off-payroll working in the private sector: summary of responses, October 2018 para 3.1