Stuck in a tax time warp

England's tax war against independent contractors has dragged innovation and entrepreneurship into a ditch but Downing Street shows no sign of reversing course.

As the Europe descends further into becoming a dangerous drag on the global economy, you’d think that there’d be an alertness to measures to drive new growth. But no, even Great Britain is caught in a time warp doing much to suppress innovation and entrepreneurship. Tax is at the forefront of the UK institutional failure.

For more than a decade, the UK tax authority (Her Majesty’s Revenue & Customs) has struggled with handling tax issues around the country's growing self-employed community. Self-employed percentages in the UK are similar to Australia's, approaching one in five people in the workforce.

Around 2000 HMRC introduced a tax ruling, IR35, that sought to capture self-employed people requiring them to pay employee PAYE withholding tax and UK social security contributions (called National Insurance Contributions). The ruling does this by declaring contractors to be employees. It’s proven a complicated messy failure.

By comparison, Australia very clearly resolved the issue, around the same time, by dumping PAYE and introducing PAYG. In this way, tax is collected without forcing people into being employees. PAYE and PAYG are totally different legislative instruments, with PAYE tying taxing authorities powers to common law employment while PAYG does not.

In the UK, IR35 has resulted in near war between the contractor community (the UK refers to them as freelancers) and HMRC. Litigation has been extensive, both by organised contractor associations against HMRC and HMRC against individual contractors.

In essence IR35 is impossible to understand. It’s an attempt by tax officials to set themselves up as arbitrators of the common law difference between a contractor and an employee. Whenever government officials do this they inevitably become draconian and oppressive enforcers of their own interpretation of the law. They have a vested interest in finding employment as they benefit by receiving revenue.

Of course for freelancers or contractors the implications of being declared an employee is the destruction of their own commercial business model. An Australian contractor recently sent me a pie chart showing how his charge rate is split into costs. His net receipt in his pocket is 45 per cent of his charge rate. It’s an instructive eye opener. In the tax and other policy areas there seems to be an ignorance of this basic commercial configuration when people become their own boss (self-employed)

The litigation battle in Britain became a hot political issue in the lead up to the last UK election. The incoming coalition committed to a review of IR35 to make the laws easier to understand and apply. I hate to use twitter speak but OMG. (Oh My God!) After a long review, the processes of ‘Yes Minister’ have prevailed.

Instead of a fixing of the IR35 issue, the HMRC has produced a new, allegedly easier to understand version of the ruling. Read it. I defy any normal person to understand what the HMRC are talking about. Even with our summary we’re still not clear.

There’s a simple principle that should guide government policy. If they expect people to follow the rules, people should be able to understand the rules. The new IR35 explanation fails this principle. It’s not going to fix the problem but expand it.

Already, commentary from the UK self-employed sector is that the new IR35 explanation has done nothing to change the underlying legislation. Advice to contractors is to fall back into protecting themselves through litigation. And the contractor associations seem to have plenty of money to conduct the legal fights.

At its core, this is deep policy failure to understand the way societies are now approaching work. The master-servant employment structure is being replaced by business structures based on the individual.

The UK tax authorities can’t conceive that individuals can be businesses and as such are entitled to business tax treatment. They don’t understand that if they suppress self-employment they suppress entrepreneurship and economic growth potential. Probably it’s not in their bureaucratic brief to care! Further, the UK government has demonstrated that it doesn’t care or understand.

The UK Treasury has issued an instruction to all government departments on IR35 in the use of IT contractors. The departments are being required to enforce IR35 where they engage IT contractors. I doubt the public servants will understand IR35. They are most likely to apply a misunderstanding that will effectively breach the law.

The Treasury instruction is to either dismiss the contractors or make them pseudo-employees. Analysis of contractor market rates indicates major reductions in remuneration as a consequence. This will result in the UK government stripping itself of high level IT skills. The government is working against its own best interests.

In failing to resolve IR35, the UK coalition government displays a lack of understanding of the changing (global) nature of business rolling across the UK. It has instead chosen to institutionally cement the UK into an economically unresponsive position that makes self-employed business entrepreneurship much harder than it should be.

Ken Phillips is executive director of Independent Contractors Australia and author of Independence and the Death of Employment.