Independent Review Recommends Abolition of IR35

March 14th 2011

The Office of Tax Simplification (OTS) released an interim report on its Small Business Tax Simplification Review last Thursday, the 10th of March. The OTS is an independent body formed in July 2010 with a remit to provide reviews and advice aimed at improving and simplifying the UK tax system. It is comprised of staff drawn from HMRC, Treasury and a number of tax experts from the private sector.

The report recommends a series of measures aimed at simplifying the tax structure for small businesses including the way tax is calculated and collected. Suggestions of note included merging Class 2 and 4 NICs for self employed, changing the April 6 - April 5 tax year to run from January to December and creating a separate taxation system for small companies with a turnover less than £2m.

The main recommendation is the merging of PAYE income tax and National Insurance Contributions (NICs). This, says the report, would remove the need for IR35. It would also, as some commentators have observed, remove the tax-advantages of operating a Personal Service Company. Such a merger however is seen as a long term option with a lengthy implementation process which is fraught with political and logistical difficulties. It will be interesting to see whether the Chancellor will elect to adopt such a radical policy.

Acknowledging these difficulties the report proposes three interim options for IR35;

1. Suspend IR35, with a view to abolishing the legislation permanently

2. Retain IR35 legislation in its existing form but with explicit commitments from HMRC to make specified changes to the enforcement of the legislation

While the report does not present either of these options as a preferable it provides a secondary alternative should the government not choose either of the first two.

3. the introduction of a genuine business test to exempt certain businesses from IR35 entirely

Even these interim options are unlikely to be implemented in the short term. The report has been timed to provide the Chancellor time to consider it before the Budget on March 23rd. It is expected that George Osborne will respond to the report in or shortly after his Budget announcement, setting a deadline for the final report from the OTS at that time.

In its own analysis of the interim options presented for IR35 the OTS recognises flaws in each. The first succeeds in simplifying the legislation and removing a burden from small business but exposes the exchequer to potential loss of tax revenue as the suspension of IR35 might cause a flood of incorporations from permanent and umbrella company employees. The second option is not to make any legislative changes to an unsatisfactory system which the OTS has a remit to reform. The final option put forward is to add another test to an already complicated and uncertain legislation. The suggestion is to have one definitive test to remove the majority of limited company contractors from the scope of the other tests. However, whatever test used could well end up becoming as difficult to enforce as the existing ones.

planIT would like to make clear that nothing has changed at this stage. The IR35 rules still apply and we would be very surprised if that changed soon. These are simply a variety of options recommended by a committee to the government which may or may not be adopted. We will follow the budget with interest and ensure we keep our contractors informed of any developments that will affect them.

You can read the full OTS report here: http://www.hm-treasury.gov.uk/ots.htm.