Clause 22 - Arrangements made by intermediaries

Finance Bill – in a Public Bill Committee am 2:00 pm ar 21 Mai 2013.

Danfonwch hysbysiad imi am ddadleuon fel hyn

Question proposed, That the clause stand part of the Bill.

Photo of Catherine McKinnell Catherine McKinnell Shadow Minister (Treasury)

Clause 22 amends chapter 8 of part 2 of the Income Tax (Earnings and Pensions) Act 2003, or the intermediaries legislation commonly known as IR35. I would like to state for the record, in the event that it is relevant, that I am a member of the all-party group on the freelance sector.

At present, as office holders are not considered to be employees, any office holders engaged via intermediaries would not fall within the IR35 legislation for tax purposes. Clause 22 seeks to amend that so that the application of IR35 extends to office holders with effect from this tax year. Members of the Committee will probably know that IR35 was introduced by the previous Government in April 2000 after being announced in the 1999 Budget and subsequently being consulted on. The IR35 legislation was then updated by the Income Tax (Earnings and Pensions) Act 2003. The aim of the legislation was to eliminate the avoidance of tax and national insurance contributions through the use of intermediaries such as personal service companies or partnerships in circumstances in which an individual worker would, for tax purposes, otherwise be regarded as an employee of the client, and for national insurance purposes be regarded as in employed earner’s employment by the client.

Prior to the legislation taking effect, an individual could use this disguised employment to avoid being taxed as an employee on payments for services, and to avoid paying class 1 national insurance contributions by providing those services through an intermediary. The worker could take money out of the intermediary, normally a personal service company, in the form of dividends instead of a salary. As dividends are not liable for national insurance contributions, that would result in the worker paying less in such contributions than either a conventional employee or a self-employed person. Of course, PAYE taxation would also not apply to the dividends.

IR35 sought to consider the underlying nature of the relationship between the worker and the engager such that if the relationship would be considered to be employment were it not for the interposition of the intermediary, the IR35 legislation would apply. Where it applies, the income received by the intermediary is deemed to be employment earnings of the worker and the worker is liable to pay income tax on it, in accordance with chapter 8 of the Income Tax (Earnings and Pensions) Act 2003.

Currently, office holders engaged via intermediaries fall under the relevant national insurance legislation so that they are in the same national insurance contributions position as those who fall within the IR35 legislation. Clause 22 seeks to equalise the tax treatment of office holders engaged through intermediaries in the same way, but what is an office holder? The explanatory notes to the clause suggest that it is impossible to provide an exhaustive list or definition of the term. However, the notes suggest that the term “office” includes

“in particular any position which has an existence independent of the person who holds it and may be filled by successive holders.”

An office

“is a separate and independent position to which duties are attached; and office does not owe its existence to the incumbent or the discretion of an organisation”.

Therefore, an office holder might include, for example, a non-executive director, but according to the explanatory notes, but according to the explanatory notes, it would not include the post of manager or head of division, as such roles will only exist as long as the organisation wishes them to.

However, the attempt to define “office holder”, which is clearly critical if the legislation is to function, has already been criticised for its lack of clarity. For example, Qdos Consulting stated:

“The lack of clear and concise guidance as to what an office-holder looks like is disappointing and will only add another layer of doubt to the IR35 legislation, something that HMRC were at pains to avoid when they overhauled the administration of IR35 last May.”

I would be grateful if the Minister could address some of those clearly critical concerns, when he responds on clause 22.

The overhaul of the administration of IR35 in May 2012 took place after the coalition agreement stated, back in May 2010, that it would

“review IR 35, as part of a wholesale review of all small business taxation”.

The Chancellor’s first Budget in June 2010 stated:

“The Government remains committed to a review of IR35 and small business tax”.

In July 2010, it was announced that the review would be undertaken by the recently established Office of Tax Simplification.

The OTS’s review, published just ahead of Budget 2011, made a number of recommendations, including that the Government should look at the wholesale integration of income tax and national insurance contributions, or that IR35 should be abolished. However, Budget 2011 announced that IR35 would be retained

“as abolition would put substantial revenue at risk”,

but the Government were committed to

“making clear improvements in the way IR35 is administered”.

Shortly after the Budget announced that IR35 would be retained, the Exchequer Secretary asked HMRC

“to undertake a thorough overhaul of the administration of this area of the tax system”.

That would include HMRC providing pre-transaction clarity and certainty and restoring trust, and the changes would

“include setting up a dedicated helpline…publishing…guidance on those types of cases HMRC view as outside the scope of IR35, targeting compliance activity by restricting reviews to high risk cases and setting up an IR35 Forum which will monitor HMRC’s new approach.”

Almost 50 pages of new IR35 guidance were subsequently published by HMRC in May 2012, which outlined the new, risk-based approach, monitoring IR35 compliance through a set of 12 business entity tests to help individuals work out the risk of HMRC checking whether IR35 applies to them.

As we know, the use of personal service companies by individuals became a particularly hot potato for the coalition when details of the pay arrangements for the chief executive of the Student Loans Company emerged at the beginning of last year. Mr Lester took up his position permanently in February 2011 and it was discovered that he was being paid off-payroll—that is, via a personal service company. That revelation led the Chief Secretary to the Treasury to announce, in February 2012, an internal audit of such appointments across all Government Departments to ensure “good value for money” and the unwinding of arrangements where necessary and “as quickly as possible”.

In May 2012, the Chief Secretary reported the findings of the review, which uncovered more than 2,400 such appointments. He declared that

“That lack of transparency cannot continue” and that there would be

“new tighter rules on off-payroll appointments.”—[Official Report, 23 May 2012; Vol. 545, c. 1159-60.], which would be implemented by September 2012.

On the same day, the Chief Secretary also announced plans to change the application of IR35 to individuals given a controlling function in a client’s organisation. The Government proposed to change the law so that controlling persons would be required to be on the payroll of that organisation and not engaged by an intermediary. However, this proposal was dropped in the autumn statement 2012 with the Government apparently concluding that their changes to the administration of IR35, along with changes to public sector recruitment practices, would be sufficient to prevent tax avoidance through disguised employment.

This fairly minor change to clause 22 is designed to ensure that office holders engaged via intermediaries will fall into IR35 in terms of their tax treatment as well as for national insurance contributions. That is part of the Government’s limited attempts to reform this thorny area. I would be grateful if, as well as addressing the concerns about the definition of the term “office holder”, the Minister could outline how many people the clause is likely to affect. In light of recent media reports, could he provide the Committee with an update on the employment of people off payroll in Government Departments and how the Chief Secretary’s plans to ensure greater transparency and tighter rules have been implemented to date?

The Minister might wish to comment on the Department for Education’s apparent continued employment of 24 academy brokers, whose role is to convince head teachers to join the academies programme, through personal service companies, reportedly on contracts of up to £1,080 a day, with some of these contracts running for up to 10 years. Is that what the Chief Secretary meant by

“new, tighter rules for off-payroll appointments”?

Photo of John Cryer John Cryer Llafur, Leyton and Wanstead 2:15, 21 Mai 2013

I am interested in the definition of personal services. It could have numerous connotations. Could my hon. Friend be more specific about that?

Photo of Catherine McKinnell Catherine McKinnell Shadow Minister (Treasury)

It is obviously a complex and thorny area of the law. I, too, would be interested to hear the Minister give a clearer definition of personal services.

There is another important area of false self-employment which the Bill and, disappointingly, the clause do little to address. According to the Union of Construction, Allied Trades and Technicians and its excellent report, “The Great Payroll Scandal”, bogus self-employment in the construction industry, from misuse of the construction industry scheme to enforced use of payroll companies, has been described as the biggest employment rights challenge in the industry. UCATT estimates that over 50% of those working in the construction sector are falsely designated as self-employed subcontractors, even  though many are permanently employed by a single firm. Those “employed” in this way are, of course, missing out on rights such as paid sick leave; holiday pay; overtime rates; redundancy pay; travel allowances; pension contributions; and employment protections. Many are forced to sign a contract stating that they are self-employed. Many are also expected to shell out £15 to £25 a week, which is deducted from their wages, to pay for these payroll services.

It should be of particular concern to the Minister that the problem is estimated to cost the Exchequer £1.9 billion a year. It is disappointing, when considering clause 22 and the Government’s actions in making a small change in this particularity difficult area, that there does not appear to be a commitment to tackle that scandal in the Finance Bill or in other legislation. I would be grateful if the Minister would comment on that matter and reassure the Committee that the Government are considering these issues, in particular, from their perspective, the loss to the Exchequer that results from it.

As I am sure the Minister is aware, the Labour party is currently undertaking a policy review on this issue, led by my hon. Friend the Member for Leeds West (Rachel Reeves). We are speaking to employers, employees, trade unions and other organisations about what action we can take to stamp out false self-employment for good without stifling genuine self-employment, which is vital to our growing economy. I would be grateful if the Minister could comment on all the issues that have been raised. Clearly it is an issue of workers’ rights and fairness in the system, but it is also about protecting revenue to the Exchequer, which is clearly vital at this time.

Photo of David Gauke David Gauke The Exchequer Secretary

I am grateful to the hon. Member for Newcastle upon Tyne North for setting out very thoroughly the background to the clause and IR35 more generally. As she said, the clause is a relatively minor matter. It aligns the tax and national insurance treatment of office holders under the intermediaries legislation more commonly known as IR35. Historically, IR35 has applied to office holders for national insurance purposes but not for tax. That means that office holders engaged via intermediaries currently pay national insurance contributions on the same basis as office holders who are engaged directly, but they are taxed differently. This small change rectifies the situation and creates parity between the tax and national insurance treatment.

Where an office holder is engaged directly by an organisation, income tax and national insurance have to be deducted at source by the engaging organisation, in the same way as they do for an employee. We expect this to be the case for the vast majority of office holders. Indeed, HMRC may still argue in the first instance that the office holder should have income tax and national insurance deducted at source by the engager, notwithstanding the terms of the clause. This small change to IR35 ensures that, where an office holder is personally required to provide the service of that office but is working through a limited company or other intermediary, HMRC is able to collect the tax that is due. The Government welcome the contribution that personal service companies make to the economy, and realise that in the vast majority of cases they are there for legitimate commercial reasons. This change creates  a level playing field for office holders, and ensures that tax cannot be avoided by putting in place contrived arrangements.

Concern has been raised that this change will be used to apply IR35 to all those working through an intermediary. I would like to assure the Committee that that is not the case. This change does not extend the definition of an office holder. The term “office holder” is not defined in statute; it relies on case law. It is worth pointing out that HMRC publishes guidance on what constitutes an office holder, and it is used widely to determine who is an office holder for PAYE purposes. It does not apply solely to IR35 matters.

An office is a separate and independent position to which duties are attached. It does not owe its existence to the incumbent or the discretion of an organisation. Examples of office holders include returning officers and clergymen. Case law recognises that a succession of individuals to a post or job title is not enough to establish an office. If, for example, the role and responsibilities can change or the engager can decide that the post is no longer needed, the individual is not an office holder. HMRC has published guidance on what constitutes an office holder; it has also published guidance on how the change applies.

I come now to definitions, and personal service companies. Personal services are provided by an individual when they must undertake the work rather than be able to provide a substitute. As for how many people will be affected by the clause, I cannot provide that information today, but I shall write to the hon. Member for Newcastle upon Tyne North about it. She asked about false self-employment in the construction industry. Several issues relate to that, including the loss of revenue. As announced at the Budget, HMRC is continuing to examine issues arising in the intermediaries market as part of wider avoidance work. That includes false self-employment in the construction industry, and it is a matter on which we continue to focus. The hon. Lady will be aware of our announcement in the Budget about offshore intermediaries. It demonstrates a willingness by the Government to act in related areas where we believe that there is a strong case.

Photo of Catherine McKinnell Catherine McKinnell Shadow Minister (Treasury) 2:30, 21 Mai 2013

Will the Minister comment further on the steps being taken by Departments engaged in off-payroll personal service company contractual arrangements because, clearly, that goes to the very heart of the public’s concern and to the very heart of the Government in many respects? I should be grateful if the hon. Gentleman would put on record what steps are being taken to deal with such worries.

Photo of David Gauke David Gauke The Exchequer Secretary

The hon. Lady raises a significant issue, albeit one that is much broader than the clause. She will be aware that the process of providing services to Government public sector workers being paid through intermediaries was not new, and one that emerged from the case involving Mr Lester. The system was used widely, particularly under the previous Government. My right hon. Friend the Chief Secretary made several announcements about such matters, and we believe that there is a need for much greater transparency.

I cannot specifically answer the hon. Lady’s question about the Department for Education and academy brokers but, in short, I say that, as a Government, we have been much more willing to deal with the matter than was the case in the past. The Departments are reviewing their work force and reporting the results to the Treasury, as part of the review of the way in which public bodies are working on such issues. I think that the Government will be saying more on that matter in due course.

The clause involves a relatively small change; none the less it will ensure that people pay the correct amount of tax. It will also ensure that there is a level playing field for office holders, and that working through contrived arrangements does not result in a tax advantage. I hope that it will stand part of the Bill.

Photo of John Cryer John Cryer Llafur, Leyton and Wanstead

I want to speak at slightly greater length on one point that was raised by my hon. Friend the Member for Newcastle upon Tyne North and answered by the Minister—bogus self-employment, especially in the construction industry. The construction industry has been highlighted, but bogus self-employment now seems to be creeping into other industries such as hotel and catering. We are essentially talking about the distinction between employed and self-employed. Traditionally, that was a hard and fast distinction, but it has become blurred over the past 20 or 30 years. To some extent, that is due to change in work practices. Many on the Committee have probably been self-employed freelance in the past, and that is completely legitimate.

However, ruses and scams—some legal and some floating on the edge of illegality—are used by unscrupulous employers. I use the term “unscrupulous employers” advisedly because respectable, law-abiding employers would not get up to that sort of thing. Unscrupulous employers use certain ruses to transfer people who are clearly employees to self-employed status on a bogus basis. If employers transfer employees to self-employment, they avoid a number of obligations, including sick pay, holiday pay, overtime rates, redundancy pay, travel allowances, pension contributions and certain employment protections, as well as employer’s national insurance.

Photo of Catherine McKinnell Catherine McKinnell Shadow Minister (Treasury)

I am grateful to my hon. Friend for highlighting a major concern, in terms of not just Exchequer return but employment rights. Does he share my concern at discovering that many teachers are paid through off-shore payroll service companies? Some of the teachers engaged were not even aware that they did not have those employment rights until they found themselves in the position, for example, of having to take maternity leave and realising at that stage that they were not entitled to it.

Photo of John Cryer John Cryer Llafur, Leyton and Wanstead

My hon. Friend is right. There is a notorious example; I was going to refer to it later but will do so now. International Subcontracting Solutions Ltd employs 24,000 supply teachers across the UK. Because the company is based in the Channel Islands and is a payroll company, it is not liable to pay employer’s NI, although technically it does employ the teachers. That is a strange anomaly which in the past Ministers would not have had to grapple with. However, with the changing nature of the economy, it is a problem that has become apparent in the past couple of years.

Returning to the practices prevalent in the construction industry, we have seen the advent of payroll companies, of which I expect the Minister is aware. Payroll companies say to employers, “Give us the contract and responsibility for your payroll duties, and we will get HMRC off your back.” They will get rid of all the duties and obligations that I previously mentioned. In addition to promising to get HMRC off the backs of employers, in the worst cases they can use tax relief claimed against workers’ expenses to fund employer’s NI. That seems to be flirting on the edges of legality.

My hon. Friend referred to a report produced by UCATT, written by freelance journalist Jamie Elliott. He invented a company called Fairbrother Builders and asked payroll companies how they could help him out with HMRC and divest him of his obligations and responsibilities. I should point out that some of the payroll companies said that that was not appropriate, that he was employing people and should continue to employ them and that they were not in the business of helping him transfer people to bogus self-employment to avoid responsibilities. However, the majority of payroll companies said, “That’s fine. We will help you out.” When Mr Elliott approached Hudson Contract, the biggest payroll company, it responded by writing a letter, which stated:

“We can save you money, 20% of your labour costs, by reclassifying PAYE staff, paying them through CIS.”

That seems to me to be, at the very least, a questionable sort of practice. The letter went on:

“Self Employed operatives, paid under CIS deduction through Hudson are not entitled to holiday pay, redundancy or notice. We are helping companies to move their PAYE labour over to CIS…Last year this saved our clients over £25M in Employers NIC, placing tax and employment law liabilities with us.”

That seems pretty disreputable to me. It also diverts a lot of money that should go to the Treasury into the pockets of the employers who engage in such practices deliberately to avoid obligations.

Photo of Ian Mearns Ian Mearns Llafur, Gateshead

My hon. Friend is making important points indeed. There are vital facets to this discussion. The employment rights aspect is of great importance. Government Members should be concerned about employment rights as well as the cost to the Exchequer. Such practices must be costing the Exchequer hundreds of millions of pounds annually. If the profits that were not being paid in taxes were being spent on something useful, such as training the future work force, we could make an argument for those practices, but I am afraid to say that the construction industry is notorious for not doing so.

Photo of John Cryer John Cryer Llafur, Leyton and Wanstead

I agree with my hon. Friend.

Photo of Catherine McKinnell Catherine McKinnell Shadow Minister (Treasury)

Both my hon. Friends have raised very important issues. Another facet that is often overlooked is the fact that such practices not only cause a loss to the Exchequer but are unfair on and exploit workers. It also creates an unlevel playing field for the many businesses that do the right thing. We have an obligation to speak up on behalf of those businesses. They pay a price by not winning contracts, because they cannot compete with such exploitative practices.

Photo of John Cryer John Cryer Llafur, Leyton and Wanstead

That is absolutely right. Winston Churchill laid the path for the Agricultural Wages Board when he became Home Secretary in 1910. He said that the best employers would be undercut by bad employers, or something along those lines. I cannot remember the quote, but I think the Committee gets the gist. We are seeing perfectly reputable employers who want to do their duty, pay decent wages and make their contributions being undercut by the worst.

When people are transferred to what I would regard as bogus self-employment, they are often given a sweetener—a slight increase in pay—but very often that comes nowhere near compensating them for what they lose in sick pay, holiday pay and so on. I will quote the standard sort of contract used by Hudson. It sounds as though I am picking on Hudson Contract. The reason why Hudson is used so extensively in the report is simply that it is the largest of the payroll firms, not because it is particularly untypical. The contract used by Hudson states that the worker

“has no contract of any type whatsoever with the client”,


“he neither has nor shall make any contractual claim of any type against the client”.

In the vast majority of cases that I know about, the employees carry on doing exactly the same job. They are instructed by the same foreman and the same manager, and yet they are suddenly self-employed and supposedly have no relationship with their former employer. That is fantasy. It is fantasy economics and it is a con.

The Hudson website states:

“Say goodbye to HMRC status issues and employment tribunal challenges.”

That is a bold statement, but, to a large extent, Hudson is justified in making that claim. HMRC challenged Hudson in 2007 on the basis that Hudson was transferring people to bogus self-employment. Strangely, HMRC lost the case in the High Court. HMRC argued that there was an implied relationship between the construction company and the freelance operative due to the reality of the relationship between them. That would make sense to most people, I would have thought, but the High Court, bizarrely—I do not know what planet the High Court was on that day, but it is not unusual for it to make bizarre decisions—said, “No, there is no such relationship”, despite the fact that there was one. HMRC lost, and since then, there has been a rapid expansion in the activities at the dodgy end of the market. In the past three years, the number of employer compliance reviews conducted by HMRC has fallen substantially.

Perhaps when the Minister responds he will tell us that the number of compliance reviews of companies is starting to rise. I hope that he will be able to say that, because that would go some way to addressing the problem, which is increasingly prominent in construction and other industries.

In the three years up to the UCATT report, published a few months ago, the number of compliance reviews and inspections had been falling consistently. That of course says to employers who want to engage in bogus self-employment, “You are going to get away with it, because HMRC is not going to come round to talk to you, look at your books or check that you are following  the letter of the law.” They will have more confidence in trying to keep cash away from the Treasury, where it should be going.

As I said at the beginning, my worry is that, while at the moment the practice is prominent in construction, it is spreading, particularly to the hotel industry; I say that from some experience in that industry. We are starting to see such bogus self-employment creep into hotels and catering. After that, it will spread to other industries. At some point, the Treasury and HMRC will have to take the issue seriously, because it clearly will have an effect on the flow of cash coming into the Treasury, which will of course have all sorts of implications.

Photo of David Gauke David Gauke The Exchequer Secretary 2:45, 21 Mai 2013

I am grateful for the opportunity to return to the subject. Although the debate has broadened out from clause 22, the area is an important one.

To respond to the points raised by the hon. Member for Leyton and Wanstead, I reiterate that the Government announced in the last Budget their proposals to deal with offshore employment through intermediaries. The consultation document on that will be issued this summer. It will look to address all the abuses referred to and ensure that offshore employers pay the full amount of tax and national insurance contributions.

Photo of Catherine McKinnell Catherine McKinnell Shadow Minister (Treasury)

The Minister mentioned the consultation. My understanding was that it would be published in May 2013—this month. He now says that it will be published in the summer. Will he clarify when precisely the consultation will be published?

Photo of David Gauke David Gauke The Exchequer Secretary

At this point, I am not going to be more precise than to say this summer. Obviously, I will let the hon. Lady know if I can be more precise.

Regarding compliance, I assure the Committee that HMRC has increased the number of compliance teams dealing with employment avoidance. A number of further teams are due to come online soon, in a directed compliance programme in this area. I am sure that hon. Members will be aware of the Government’s efforts to support HMRC so that compliance activity can be stepped up across the board.

It is also worth saying that the offshore employment through intermediaries consultation document is the first part of an HMRC project into the avoidance of tax and national insurance contributions through intermediaries. HMRC will continue to gather evidence about the other forms of employment tax avoidance referred to today.

In a spirit of generosity to the hon. Member for Newcastle upon Tyne North, I will now be more precise on when the consultation document will be published: I can reveal for the first time that it is due to be published on 30 May.

Question put and agreed to.

Clause 22 accordingly ordered to stand part of the Bill.