IR35 update – abolition of Business Entity Tests from April 2015

Posted by David on November 24, 2014

Many readers will be aware of the ‘IR35’ legislation which was enacted some 14 years ago. It provides that if a worker supplied by a Personal Service Company (PSC) contractor would be an employee of the ‘end user’ of the service, but for the use of the PSC, then virtually all the income from the contract must be subjected to PAYE and NIC by that PSC. However employment status remains a matter for case law and the courts (or tribunals), rather than statute, to decide upon, thus a considerable degree of uncertainty remains.

In 2012 HMRC therefore announced a series of ‘Business Entity Tests’ (BETs) which would enable PSCs to self-assess whether they are at high, medium, or low risk of an ‘IR35 review’ by HMRC. However the ‘IR35 forum’ (a joint working initiative between HMRC and various other private sector bodies having an interest) has now confirmed the recent rumours, that the BETs will no longer be used from April 2015.

This has led to some speculation that the whole IR35 process may now be ‘withering on the vine’; however this is not quite how ET4B sees it.

In background, a House of Lords Select Committee was appointed in November 2013 to consider the consequences for tax revenues arising from the increasing use of personal service companies. After considering verbal and written evidence from various interested parties the Committee provided a report and the Government’s response to this report was published in June this year. In summary, and whilst the Government acknowledged that abiding by IR35 creates a significant cost to contractors, the simple abolition of the IR35 rules (as proposed by some, including the Office of Tax Simplification) was felt to be ‘unwise’ given the ‘Exchequer protection’ that the legislation is considered to generate.

On an even more cautious note, the Government also commented that it was unconvinced that the resources currently allocated by HMRC ‘were sufficient to ensure compliance with the IR35 legislation’. In addition (and on a separate point), the Government further committed to challenge in particular (non-PSC) ‘umbrella’ payroll companies who incorrectly apply for or misuse HMRC dispensations.

In a slightly more positive tone, some noises were made in the June response to suggest that HMRC guidance and requirements would be updated to ensure these become more relevant and pertinent. It is perhaps with this in mind that the abolition of the BETs has been announced. Rather than slowing down HMRC’s impetus on IR35, we think it is simply a question of HMRC belatedly accepting that the BETs do not fit the purpose for which they were originally intended.

Within the Public Sector there has been a tendency incorrectly to treat the BETs as if they are the only valid accurate barometer of IR35 compliance, thus ruling out many legitimate independent service providers and making the process less competitive.

Within the private sector there has always been a reluctance to accept the BETs as a valid guide to IR35 and in practice these have been ignored. We suspect that most PSCs who take the tests would at face value be deemed by HMRC to be at ‘high risk’ of review, but this strongly contrasts with the fact that very few of these contractors actually see themselves as within IR35. One of these assumptions must be wrong, and (as we always suspected) HMRC has in effect accepted that it is the BETs that are fatally flawed. The previously published HMRC Employment Status Indicator (ESI) tool (whilst not focussed directly on IR35, and despite having its own limitations) in truth provides a more accurate assessment of employment status.

Therefore whilst we cannot expect the HMRC IR35 review teams to simply ‘go away’, we can assume that in future HMRC will not rely simply on the (erroneously slanted) Business Entity Tests as justification for either commencing, or continuing with, a review.

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