IR35 costs 'may outweigh benefit'

The cost to business of complying with the controversial tax rule known as IR35 may outweigh the amount of avoidance which it is believed to prevent, a House of Lords inquiry has found.

HMRC claims that £550 million of tax and national insurance would be at risk if IR35 was abolished
HMRC claims that £550 million of tax and national insurance would be at risk if IR35 was abolished

IR35 is intended to prevent the abuse of personal service companies to disguise employees as freelancers in order to gain more advantageous tax treatment.

But critics say it has a harmful impact on small companies set up for legitimate reasons by contractors such as IT professionals who work on short-term contracts.

In a new report, the House of Lords Select Committee on Personal Service Companies said that HM Revenue and Customs (HMRC) had failed to provide a sound basis for their claim that £550 million of tax and national insurance was at risk if IR35 was abolished.

HMRC " need to do more to demonstrate that the revenue protection they claim for the IR35 legislation outweighs the costs it imposes", said the report.

Committee chairwoman Baroness Noakes said: " During the inquiry, it became clear to us that there is an increasing use of personal service companies by freelancers and contractors, who are part of the UK's flexible workforce.

"There are many reasons for the use of personal service companies, including the possibility of reducing tax and national insurance bills. The Government's anti-avoidance legislation, often referred to as IR35, is complex and raises its own problems.

"We found that there is a general lack of information of how widespread the use of personal service companies is in the UK economy and that this is due, in no small part, to the absence of reliable information collected by HMRC.

"This could be rectified by amending the personal tax return and employer year end declaration and making the questions on service companies compulsory, rather than optional.

"HMRC failed to demonstrate that they had a sound basis for the £550 million of tax and national insurance that they cited as being at risk if IR35 were to be abolished or suspended. The deterrent nature of the IR35 legislation is its main rationale.

"We recommend that HMRC publish a detailed assessment of this figure and we also call for an assessment to be made of the cost to the taxpayers affected by the rules."

The report also found that some low-paid workers may be employed via personal service companies without being made aware that this means they have fewer employment rights, and called on the Low Pay Commission to carry out an assessment of the issue.

An HMRC spokesman said: " Many personal services companies are used for genuine commercial purposes, supporting labour market flexibility, but the report also recognises that some are used for tax and national insurance avoidance, underscoring the continued importance of the IR35 rules.

"We will continue to work closely with stakeholders such as the IR35 Forum, to make the rules easier to operate in the interests of the majority of taxpayers who play by the rules."