New burdens for employers?

The Government and HMRC continue their assault on perceived tax avoidance and their move towards shifting the compliance burden onto employers and end users of services. HMRC has recently consulted on two areas where it feels that there exists significant non-compliance and, as a result, lost tax revenue. The first consultation is on the effectiveness of legislation designed to catch disguised employment, known as IR35; the second is the tax treatment of termination payments to employees.

Contractor tax burden

Shifting the responsibility for ensuring that an independent contractor complies with their tax liabilities from the individual to the service user would be a fundamental change to existing practice, with major repercussions for those that outsource services.

Requiring companies that engage contractors and freelancers to take on a greater role in the process is one of a number of options set out by HMRC in a “discussion document” on the effectiveness of IR35. It has been seeking views in order to “better understand the issues and explore options for reform”.

It is common practice for businesses to take on consultants operating through personal service companies (PSCs) without worrying whether or not they truly are self-employed. HMRC said there was a “growing body of evidence” suggesting significant non-compliance with the rules. In particular, it said that the number of people paying tax under IR35 had “remained fairly static” since the rules were first introduced in 2000, but the number of PSCs in operation had increased “substantially”.

Moving the onus to employers clearly makes sense from HMRC’s perspective, given the difficulties of checking the engagements of multiple individual PSCs and the difficulty of recovering any tax which proves to be due.

However, from the engager’s perspective, the prospect of having to assess the status of all of their PSC contractors will be extremely unwelcome. Employment status is notoriously uncertain and, in practice, it seems likely that many larger corporates would opt for a conservative approach and apply PAYE where there is any significant doubt – or, in appropriate cases, look to engage individuals through intermediaries so as to shift the risk away from them.

This initial consultation closed on 30 September, after which the Government will decide whether to proceed with reforming the rules. Any proposals would undergo a full consultation, HMRC said.

Termination payments

Possible changes to the taxation of termination payment are based on recommendations made by the Office of Tax Simplification last summer. The changes could include replacing the existing £30,000 exemption from income tax and national insurance contributions (NICs) with a new exemption for redundancy payments only, which increases proportionately with the employee’s number of years’ service.

Under the current regime, the first £30,000 of a non-contractual payment can be made tax free with the remainder subject to income tax (but not NICs), whereas a contractual payment in lieu of notice (PILON) is taxable and subject to NICs. The Government believes that not only is the regime complex, it also leads to scope for avoidance. “The Government thinks that it is not right to have a system that is so complex that many people are not able to have certainty that they have paid the correct amount of tax and NICs when they leave a job,” HMRC said in its consultation on the proposals, which closes on 16 October 2015.

It is undoubtedly true that the current rules on taxing termination payments, whilst perhaps logical to a tax lawyer, do present headaches and risks of unintended errors for companies trying to comply with them. In addition, in its consultation paper, HMRC said that it had “evidence” that some employers and employees were taking advantage of some of the current complexities, for example by arguing that a taxable PILON was actually a payment for breach of contract so that there was no NIC liability and the payment was only taxable on amounts over £30,000.

Replacing the current system with a blanket rule that all termination payments are taxable, and subject to national insurance, save for a simplified, single exemption linked to length of service and redundancy would no doubt make the rules easier to apply. But clearly, given that “true” termination payments are currently not subject to NI at all and only taxable to the extent that they exceed £30,000 regardless of the circumstances of termination, the proposals would result in an overall tax take for the Government and would in many cases push up the costs of termination for the employer.