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This is traced back to the Government's Regulatory Impact Assessment of the Welfare Reform and Pensions Bill, which was published in May. Appendix 6 deals with 'National Insurance Liability of Service Provision through intermediaries'.
A Regulatory Impact Assessment (RIA) is a Government report which assesses the risks and benefits of proposed legislation. In this case, it related to the impact of IR35, and revealed that the Government's own prediction was that up to 66,000 small businesses would face closure.
It said: The costs of setting up a service company are shown in Table 7 below for the estimate of between 33,000 and 66,000 companies that will cease their service company arrangements and migrate to the client’s payroll.
It also made the assumption that these companies would migrate to the client's payroll.
Four years after the introduction of IR35, the Regulatory Impact Assessment makes interesting reading. However, when the Paymaster General, Dawn Primarolo, has been questioned recently about the actual impact and effect of IR35, she has been unable to reveal any concrete figures. (See Shout99 article: IR35 Information? No data, not possible - January 2004)
Extracts from the RIA
One aspect of the RIA was to examine the predictive risk. It says:
Risk Assessment
If the proposed changes are not implemented there will be a number of consequences:
- Individuals disguising employment in this way reduce their NICs liability compared to those who work directly to the employer. The loss of revenue to the National Insurance Fund is increasing and is, in effect, borne by other individuals and employers who do pay their fair share.
- The number of service companies and other intermediaries used to disguise employment will continue to rise significantly. The number of service companies is estimated to have risen from the range of 20-50,000 to 33-66,000 in the past few years. Furthermore, with the increased incentives for small and medium companies, it is anticipated that the rate of growth would accelerate. This could mean that the effect of the targeted incentives provided to encourage entrepreneurship was diluted.
- People who work through intermediaries can lose their employment rights under the law. The number of such workers would continue to rise.
- Parallel measures are being proposed for income tax through PAYE from 6 April 2000. If the NIC measures are not implemented, the two systems will be out of line, which would impose an extra administrative burden on business.
It also looked at the alternatives:
Options
Several options were identified. The key options are summarised below.
- Do nothing. Individuals have a right to organise their affairs in the most efficient manner for tax and NICs. However, the risks indicated above would continue; we think this is unacceptable and unfair to those who do not organise their affairs in this way.
Introduce a general anti-avoidance provision to cover the use of intermediaries that - disguise employment. When we consulted on similar proposals before, there was opposition to general anti-avoidance measures in principle. Also, this would not be an efficient way of deterring these arrangements, given the numbers involved and the uncertainty such a provision would introduce.
- Bring dividend income into NIC liability. Workers engaged through intermediaries often take the bulk of their remuneration in the form of share dividends, which are not liable for NICs. It was therefore considered whether dividends should be brought into NIC liability to restore the parity. We concluded that it would be extremely difficult to devise effective legislation which could define dividends in such a way so as to exclude dividend income which originated from genuine enterprise and investment.
- Outlaw the use of intermediaries in the provision of personal services. This would unnecessarily constrain the operation of the labour market and might discourage genuine enterprise. Not every service company (or similar) is set up to disguise employment.
- The recommended option - introduce legislation which allows the substance of the relationship rather than its contractual form to determine NIC liability. It was concluded that this would be the fairest way to restore the intended use of the National Insurance legislation.
It also assesed what it perceived would be the benefits:
Benefits
The benefits of the proposed measure are that:
- it will protect the National Insurance Fund from a loss of revenue. It is estimated that the additional revenue to the National Insurance Fund from 2002 will be around £220m a year.
- it will restore fairness in competition by ensuring that employers who engage employees through an intermediary such as a service company do not enjoy more favourable NIC treatment then those who employ workers direct; and
- if it has the effect of encouraging service companies to transfer their workers to a payroll system, it will restore employment protection to many of the workers who are currently engaged through intermediaries - on the assumption that, for many, the current attraction of engaging staff through an intermediary is to reduce revenue costs.
It concluded with a summary and recommendations:
Summary and recommendations
These changes will:
- protect the National Insurance fund from loss of revenue;
- restore fairness in the workplace by ensuring that those who use intermediaries to disguise employment do not enjoy a fiscal advantage over competitors who employ workers direct;
- restore the protection of employment law to workers who transfer to direct employment as a result of the new rules; and
- strengthen the Government’s drive to encourage business by enabling it to target incentives at genuine enterprise
Alternative RIA
At the time of the publication of the RIA, there were wide-spread concerns that the information in it was an under-statement of the adverse effects that would happen to small businesses; and an over-estimation of the amount of revenue IR35 would bring in for the Revenue.
A few months after the publication of the Government's RIA, freelancer tax expert, Kevin Miller, who regularly writes for Shout99, carried out an alternative regulatory impact assessment basing his research on the Government's estimate that there are 50,000 service companies involved in 'disguised employment'.
In 1999, Kevin Miller predicted:
- A potential tax loss of £36 million;
- A possible VAT loss of £14 million;
- Tax losses if contractors move overseas of up to £580 million;
- Corporation tax losses through falling profits of around £75 million;
- Additional Inland Revenue compliance costs of £1 million;
- Annual compliance costs to businesses of around £40 million higher than Government's estimates.
- Additionally, there is a potential loss to the UK economy of £18 billion to £30 billion if major IT and engineering projects migrate overseas either to follow UK contractors or if rising UK costs leads to outsourcing to other countries.
Reflecting on what has happened over the last four years Kevin Miller said: "It's useful to remind ourselves how misguided the Governments original assumptions about contractors were.
"For them to conclude that "between 33,000 and 66,000 companies that will cease their service company arrangements and migrate to the client's payroll" reflects the Government's total lack of comprehension about what knowledge based contractors were doing. They thought that these contractors really were disguised employees and could or would join their current client as permanent staff!
"It's also interesting to note that one of the stated outcomes of IR35 would be to "restore the protection of employment law to workers who transfer to direct employment as a result of the new rules;" If anything IR35 has made matters worse by not aligning employment status with IR35 taxation status so employers are being encouraged to engage workers through an intermediary so that employment risks are minimised. It's a pity there are no reliable figures available about the costs and benefits of IR35 but I suspect my figures were a lot nearer the mark especially with regard to the compliance costs!"
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Editor's note:
I am grateful to Anne Redston, tax specialist with Ernst&Young for providing the following information about the figures. I think this clarifies the origins as much as possible. I have added her comments as an 'edit' to the original story (May 7, 2004: 11.30am)
Anne Redston said: "The answer to your question on the 66,000 is that it was in para 15 of the Regulatory Impact Assessment for the Welfare Reform and Pensions Act, which included the NICs provisions for IR35. But this moved subsequently. At para 2.2 of my book I say:
Number of service companies
Not all contract staff have their own service companies. Some are employed directly by agencies who supply them to clients; others are taken on by employers directly, using fixed term contracts. But by the end of the millennium there were said to be roughly 66,000 personal service companies (WRPA, Regulatory Impact Assessment, para 15). This was probably an underestimate, since the projected income from IR35 increased from the original £475m in September 1999 (IRPR 23 September) to £900m in the Budget 2000 Red Book. This discrepancy was explained by Dawn Primarolo in the House of Commons as follows:
'[For] our original assessments we estimated the number of companies that were using the loophole we described. We were challenged about this estimate, and?I asked the Inland Revenue to assess thoroughly through our network the number of companies that appeared to be using that mechanism?That is where the new £900m figure came from. In truth, the avoidance mechanism is being used far more extensively than we had anticipated.'(Hansard 3 May 2000, Col. 217)
Therefore, as at March 2000, government research suggested that around125,000 companies would be brought within IR35, and there are of course others who remain outside the regime. This numerical estimate was broadly confirmed by the Revenue during the judicial review case (R v CIR (oao Professional Contractors Group Ltd)[2001] STC 629 ? see 2.4). They said that in 2000/01 there were between 90,000 and 120,000 PSCs; however they estimated the cost to the exchequer (if IR35 had not been implemented) at a much lower £350m. The reason for the discrepancy was not explained.
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The full Government RIA is available here: The Welfare Reform and Pensions Bill Regulatory Impact Assessment
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Susie Hughes © Shout99.com 2004
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