IR35 Guides - Are you inside or outside IR35?

This opinion piece was written by Marc Morris, from 1st Option.

As we know, the increasing numbers of people choosing to work in a flexible capacity shows no sign of abating, with lifestyles, work trends and economic factors all exerting an influence.

The demand for more non-standard workers who are happy to turn their backs on traditional permanent employment and work flexibly, is growing all the time.

Tax yields vs. flexible labour

Whilst a flexible labour market assists UK PLC in attracting inward investment, the Treasury is understandably concerned with the negative effect on tax yields.

To put it another way, the government is currently in conflict; it wants to protect the Treasury's tax income, yet with an estimated 1.5 million freelance workers, it equally recognises the value of the UK's labour market flexibility.

At the start of the Coalition government's term in 2010, the arrival of the Office of Tax Simplification was generally regarded as a positive development and highlighted the new administration's determination to get to grips with the many complexities of the UK tax manual - IR35 was one of their "projects".

The Government claims it wants to appease taxpayers by showing that it intends to provide greater clarity as regards their employment status.

However, recent announcements stating that the abolition of IR35 is not a viable option, demonstrated that the Government is being forced to make some tough choices between the future composition of the labour market and the amount of tax it collects.

Agency Workers Regulations

As we approach the latter stages of 2011, the arrival of the Agency Workers Regulations is adding more pressure to the situation as the desire by freelancers to avoid being in scope has encouraged many more to move to incorporate, further reducing the amount of PAYE and NIC's that will be collected.

In addition, the Managed Service Companies legislation continues to discourage advisers from offering guidance on IR35 status, worsening the situation.

Finally there is added pressure brought about by steep inflation, rising living costs and stagnating contractor rates which all lead contractors to seek more tax efficiency if they can.

Determining whether a contractor is caught by IR35 or not, or whether the Agency Worker Regulations apply, is not always straightforward, but a trend is becoming clear; many more freelance professionals are choosing a limited company approach.

Are contractors an 'easy target'?

Many claim that HMRC see contractors as an easy target. They do not have the financial resources of big businesses and find themselves caught between fighting lengthy and costly legal proceedings and accepting defeat, sometimes condemning themselves to harsher tax bills than necessary.

It is wrong to assume that all contractors look to exploit IR35 rules to simply seek a tax advantage. The vast majority would happily trade a little tax efficiency for an effective "litmus test".

Unfortunately there appears to be a disconnect between the approach taken by freelancers, many keen to simply find a way to know whether they should adopt a "pass" or "fail" position, and the those of HMRC whose determination to visibly police the rules have brought about some unfortunate legal proceedings.

Those with fortitude, determination and financial resources have fought and (for the most part) won in court - others have been quietly cowed into submission.

The IR35 Forum

One seemingly welcome development to find a workable way forward is the IR35 Forum, a body that brings tax collection authorities, tax payer representatives and tax compliance specialists together to find solutions to the problems that exist around the administration of IR35.

The forum is tasked with finding changes that will increase the efficiency with which the legislation is administered; it will also measure the visible improvements that it brings about.

However the stock of HMRC is so low, it comes as no surprise that recent reports suggest that their own IR35 advice line is barely used at all by professional freelancers, presumably as a consequence of minimal trust and a perception that it will work against a contractor's interests

It is crucial that the entire approach adopted by the IR35 Forum body is more than just window dressing and that it is able to find some very real and very workable strategies to balance tax collection with fairness.

Early signals indicate HMRC sorting different contractor scenarios into high, medium and low risk to assist contractors to make more informed judgements about their status.

The big question is will they ever be able to accept that they need to soften their approach to policing and open their activities up to a degree of external scrutiny and monitoring?

Current opinion in contractor circles appears sceptical at best.