Finance Bill

As I shall come on to say, I think that a pause for reflection, thought and analysis of how we can get the legislation right could have a positive impact on tax revenue. The first thing to note about schedule 3 is that the proposals are a clear acknowledgement that IR35 has failed. If the Government had got IR35 right, they would not need to bring further complex legislation before the House to attempt to police the borderline between the employed and the self-employed. Many hon. Members will remember that in 1999 the Government caused significant controversy in the freelance and contracted-out community with their proposals on IR35—so-called because they were not announced in the Chancellor’s Budget speech, but in Inland Revenue press notice 35. The Government said at the time that that would raise £300 million for the Exchequer, and cost it just £55,000 a year ongoing to implement. However, of the IR35 investigations known to the Professional Contractors Group, 1,405 concluded that the taxpayer in question was outside IR35, and only three concluded that the taxpayer was within its provisions. The Government have repeatedly refused to publish any figures on the amount of revenue collected under IR35 or on its ongoing cost impact for contracts. The truth is that IR35 has been a hugely expensive failure. It has left thousands of freelancers in an uncertain tax position and created serious difficulty in planning ahead. It has cost untold millions in compliance checking, and whole galaxies of the blog universe have been devoted to the intricacies of IR35 compliance. We appeal to the Government to postpone the implementation of schedule 3 to assess the reasons why its predecessor—IR35—failed; to consider the steps needed to ensure that schedule 3 is not a costly failure in the same way as its predecessor; and to establish whether the Treasury will undertake to measure the revenue raised by schedule 3, despite its refusal to do so in relation to IR35. That investigation would provide an opportunity, too, to see whether IR35 is still necessary. If schedule 3 is adopted, there will be an even more complex tax framework for the taxation of freelance workers who have incorporated than there was before. Companies outside IR35 will be on one regime; companies inside IR35 will be on a second regime; and there will be a third regime for companies covered by schedule 3. Yet again, the Government have introduced highly complex and controversial legislation that is not properly thought through. They have found that it does not work properly, and to try to fix some of the problems that they created in their first round of tax law they are introducing more complex legislation that is not properly thought through either. I should like to take the opportunity to explode a myth peddled in relation to both IR35 and schedule 3. The proposals are not about employment protection. The impact of schedule 3 will be to change the tax status of individuals working through companies that fall within the definition of a managed service company. It will not change their employment status. Of course, it is wrong for people to be forced to give up their employment rights by being pushed unwillingly into managed service companies, but the proposals will not have any impact whatever on that problem. If the Government wish to deal with it, that is not the way to do it. A fundamental problem with schedule 3 is the collateral damage that it will cause. As drafted, the provision could hit many genuine freelancers who operate entirely legitimately and are genuinely self-employed—they are not employees. The consultation document asserts that the ““underlying nature”” of the relationships established by workers in MSCs is ““almost invariably”” one of employment. No evidence is given to support that assertion in the consultation document, and the Professional Contractors Group has challenged it:"““This ignores the possibilities that MSCs can be used for commercial relationships, and often are.""PCG has relatively few members who work via MSCs but those that do are generally conscious of IR35, have no wish to be employees and make a point of using IR35-compliant MSCs.""Several have contacted us following the announcement of the proposed changes to make it clear that they operate commercial relationships and are in no sense employees.””" The Chartered Institute of Taxation has looked at the problem, too, and it says:"““Our main concern is distinguishing between Managed Service Companies and Personal Service Companies…There are workers that operate through a PSC without failing IR35, but who do not have time to manage a company and will therefore outsource its functions to a professional…It is important that the legislation clearly distinguishes between these PSCs and MSCs.””" Freelancers who outsource part of the financial and administrative functions relating to their company to advisers are in danger of being caught by the provisions of schedule 3—that is a key point. Outsourcing routine administrative work to allow the worker in question to concentrate on what he or she does best, whether it is IT, engineering and so on, could walk them straight into the clutches of schedule 3. The nature of their working practices and their relationship with their end client is wholly irrelevant to their tax status under schedule 3. The key question is posed by proposed new section 61B (1) (d) of the Income Tax (Earnings and Pensions) Act 2003—ITEPA—which is part of schedule 3. We must ask whether"““a person who carries on a business of promoting or facilitating the use of companies to provide the services of individuals…is involved with the company.””" That is the issue that determines tax status, and it is the relationship with specialist advisers that is critical to the whole framework. Any company involved with an MSC provider is caught by schedule 3, whether someone is genuinely self-employed and in business on their own account or not. Their factual relationship with their end client is wholly irrelevant under schedule 3. The Law Society expressed concern that the test of involvement is ““enormously wide””. The question that every freelancer up and down the country must ask is whether her professional advisers could fall within the category of an MSC provider under the meaning of paragraph (d), and it is not an easy question to answer. It is highly likely that, under the provision as drafted, it would take at least a couple of cases going through the courts to determine the answer, and the uncertainty surrounding the meaning of paragraph (d) is a critical reason for supporting amendment No. 1 and postponing the implementation of those proposals until they have been fully thought through. Without qualification, paragraph (d) would hit any freelancer who uses an accountant to draw up her company tax returns, so its scope is narrowed by proposed new section 61B(3), which states:"““A person does not fall within subsection (1)(d) merely by virtue of providing legal or accountancy services in a professional capacity.””" The meaning attributed to that carve-out will be critical in determining the reach of the legislation. There are at least three possible approaches to the carve-out and the type of services that are relevant in the context. First, under a narrow approach, the carve-out would provide safe harbour only for basic, traditional accounting services such as book-keeping. Secondly, the widest definition could cover any services ordinarily provided by accountants. The third approach would apply to accounting services ordinarily provided in the course of an accountancy business. We need much greater clarification—that is why we need a delay and a report—about the range of services that are currently outsourced and whether they would trigger the operation of schedule 3. Those are services such as setting up and registering companies; invoicing; company secretarial services; IR35 compliance checking; routine tax advice such as guidance on the different rules governing companies and sole traders; and other assistance on regulatory compliance. Almost all those services are frequently performed by accountants, so it would not cause a problem if the second, wide interpretation is the correct one. However, if the third, middle way—the more restrictive option—is correct, the setting-up of companies and company secretarial services may fall outside the carve-out for an accountant. They are services provided by accountants, but they are more closely associated with lawyers than accountants, so they could be treated as MSC-type services if provided by an accountant, but not if provided by a lawyer. The Institute of Chartered Accountants has expressed concern about the issue, and it says:"““The legislation is ambiguous about whether firms of chartered accountants and tax and business advisers who as part of their other services advise clients about the best structure through which to trade and provide the necessary company secretarial services to enable them to do so, are within the definition of ‘an MSC provider’.””" Her Majesty’s Revenue and Customs has indicated informally that such activities should not turn accountants into MSC providers. However, as the Institute of Chartered Accountants points out, there is no substitute for a legal definition, and we propose to table amendments in the Public Bill Committee to clarify the operation of the safe harbour in proposed new section 61B(3). The Opposition believe it is unfair and unwise to impose the new regime on freelancers while such uncertainty attaches to the scope of proposed new section 61B. The Chartered Institute of Taxation points out that there is a real danger that"““uncertainty could render the legislation unworkable or difficult to enforce””." The IR35 precedent is not a happy one. Susie Hughes, founder and editor of the specialist contractor website Shout99, said:"““It is clear that contacting is a very complex business, and the new legislation has caused a headache for many contractors, who are still unsure about how to comply with the new rules.""The majority of freelancers who visit Shout99 are very knowledgeable, but the last-minute changes in the Budget knocked many sideways.””" Members should be aware that the Government maintain that these rules are in force as we speak. Despite the fact that they are unclear, they were due to come into force on 6 April. There is another twist in the tail. A freelancer might have an entirely compliant relationship with her professional adviser which does not go beyond the provision of accountancy services within the meaning of proposed new subsection (3). However, she could still end up with MSC status if her accountant was providing non-compliant services to other companies. Her accountant’s work for other companies would taint all their clients, and in assessing whether she is at any risk of falling within the scope of schedule 3, a freelancer therefore has to look not only to her own relationship with her professional advisers, but at the services that they might be offering to other people. This uncertainty is made even more problematic when one turns to the new section 688A of ITEPA, which is also introduced by schedule 3. That gives the Treasury the power to introduce secondary legislation to impose liability for the tax debts of an MSC and levy them on third parties. The Law Society described this section as ““extremely wide”” and stated that it"““could cover a wide number of people who do not actually benefit from the provision of the MSC services.””" The Chartered Institute of Taxation has also expressed the concern that the proposals are ““unnecessarily wide””. The third parties potentially caught by the provisions are set out in proposed new section 688A(2). They include any person"““who (directly or indirectly) has encouraged, facilitated or otherwise been actively involved in the provision by the MSC of the services of an individual””." The phrase"““encouraged, facilitated or otherwise been actively involved””" indicates the potential for a much wider application of the provisions than the consultation document suggests is the Government’s intention. The provisions pierce the corporate veil, leaving directors, employees and payroll clerks in the firing line. The Chartered Institute of Taxation expressed the concern that although the HMRC says it wants to target the controlling minds of a scheme provider, ordinary employees of those providers might well be hit with tax debts, as they could be seen as encouraging and facilitating the provision of services through an MSC. There is also no firm guarantee that I can see in proposed new section 688A that someone who works as a contractor through a managed service company will not end up becoming liable under this section. Furthermore, there is every chance that the end-client might be viewed as having encouraged the provision of services of the worker via an MSC. According to the Law Society,"““It is quite possible that a client might be caught if it encourages involvement . . . the word ‘encouragement’ introduces an extremely wide concept . . . We think this goes too far and could cover something that was entirely informal where the party encouraging received no benefit and no involvement . . . it leaves too much discretion with HMRC.””" The Law Society goes on to point out that leaving end-clients on risk for the tax debts of the freelancers and contractors that they take on could have a highly disruptive effect on outsourcing in Britain.