Executive summary
ACCA is pleased to comment on the consultation into taxation of ‘controlling persons’. These proposals are clearly a response to the revelations of early 2012 concerning the ‘off-payroll’ taxation arrangements of significant numbers of highly paid public sector employees. However the proposals are not directed at the public sector alone, but at all businesses in the UK. ACCA is concerned that the tight timetable for development of the proposals, and limits on HMRC resource have reduced the scope to give full consideration to the impact on the wider economy.
A fundamental concern is that the proposed measures could create new obligations which would not otherwise exist. If the controlling persons who are the target of this legislation are disguising their status for tax purposes as employees, then it is correct that their income from the engagement should be subjected to tax as employment income. However, if the legislation acted to inflict employment taxes upon individuals who would not on any other analysis be a disguised employee then this would represent an apparently otherwise unwarranted extension of the tax regime.
ACCA is puzzled by the apparent contradiction between the government’s avowed support for small business and praise for the highly skilled, adaptable and mobile workforce that the UK economy is able to call upon, and these proposals which will act as a huge disincentive for the most able managers to share their services between a range of businesses, crippling the very responsiveness which has been hailed as fundamental to the agility and responsiveness of UK business.
Transparency is about knowing things have been done, rather than necessarily doing them for yourself. Given that the policy aim is to ensure that controlling persons are correctly meeting their tax obligations, and that engagers have an assurance that this is the case, ACCA would suggest that rather than implementing the hugely disruptive proposal to create an entire new structure of PAYE withholding, the same aim could be achieved by imposing a reporting obligation on engagers and controlling persons to notify HMRC of any controlling persons contracts which are implemented, perhaps modelled upon the existing return regime under s16 TMA 1970.
Opening comments
The consultation states that it is taking place at Stage 2 of the Consultation Framework, after the objectives have already been established. ACCA has identified a number of shortcomings with the proposals as they stand, and is encouraged by assurances it has received that answers to Question 3 of the consultation, proposing alternative strategies to deal with the issues identified, will be considered constructively, notwithstanding that this might more properly fall within Stage 1 of the Framework.
These proposals are clearly a response to the revelations of early 2012 concerning the ‘off-payroll’ taxation arrangements of significant numbers of highly paid public sector employees. Though not explicit in this paper, the link is clearly made in the Alexander Review and the related research. If these proposals were to be restricted to those entities covered by the Managing Public Money Framework then it would be more reasonable to conclude that an adequate analysis of the issues had been conducted in respect of all the parties affected and it would be safe to proceed to the latter stages of Stage 2 of the Consultation Framework.
However the proposals are not directed at the public sector alone, but at all businesses in the UK. ACCA is concerned that the tight timetable for development of the proposals, and limits on HMRC resource have reduced the scope to give full consideration to the impact on the wider economy, and in particular the number of private sector businesses which utilise the services of individuals in what might (depending upon the final definition) be ‘controlling person’ roles but in a temporary capacity and through intermediaries. Nor is there any indication that the rationale behind the decision of private sector businesses to operate in this way has been subject to detailed consideration.
We agree that there must be transparency of the use of public funds spent on public services. Whatever one’s analysis of the social contract between Crown and subjects or citizen and state, there must be a degree of openness and trust for the system to operate correctly. However, this does not extend automatically to the commercial world. There are many situations where commercial confidentiality is key, and while it is true that shareholders have a direct interest in the remuneration paid to permanent members of the management of the company, the same is not true of the other expenses of running the business, including the short term retention of specialist expertise not otherwise available within the business, and which will be of no ongoing value to the business.
Nor is it clear that industry has the same issues in respect of budgetary constraints. While there may be problems with excessive boardroom pay, this is not linked to tax directly. When businesses hire an interim director it is because they need someone with a very special skill set, and not one which they want (or need) to pay for on a permanent basis. These people very often are simply not employees under any of the classical tax definitions – in particular the “Master and Servant” view, but also on basis of Mutuality. They do not have, and do not want, the kind of long term buy in to the organisation that a permanent manager would have. They do not expect the paternal benevolence from their engager that a normal employee might, nor does the employer expect the same level of filial devotion and commitment in return that it would hope for from its long term employees.
The introduction to the consultation seems to indicate that HMRC and the Treasury have two aims in mind – firstly, to tax public sector contractors correctly, and secondly, to ensure transparency in the case of all ‘controlling persons’. There is a significant difference between providing an assurance that an individual is meeting their tax obligations, and imposing upon someone else an obligation to deduct taxes and NICs at source in respect of that individual, and pay over tax and employers NICs which might not on any other analysis be due in the absence of this legislation.
Although comments have not been specifically invited on the tax impact assessment, it seems emphasise doubts over the effectiveness of the whole proposal, as the likely economic impacts identified by it range from “negligible” to “small”. If this is the case then it surely raises the question of why the whole complex process of imposing new legislation (rather than simply enforcing the existing provisions) is required.
This would be a worry in itself, were the impact assessment complete. However, ACCA has grave concerns that the assessment fails to recognise significant costs which would be imposed by forcing businesses to introduce the new withholding regime. Existing contracts with corporate service providers would need to be rewritten to accommodate the new deductions from contractually agreed payments. The imposition of employer NICs on sums due to the service providers would increase engager costs by 13.8% at a stroke. A company which had budgeted £100,000 for an interim Finance Director while looking to recruit a permanent replacement would need to either increase its budget by around £14,000 or reduce its offering in the marketplace to around £88,000, together with the promise to any interim considering the role that the whole sum would be subjected to tax and NICs at employee levels before being paid to the individual’s company.
The consultation is silent as to how double taxation of the sum will be avoided on extraction from the company. Without such relief the market for individuals providing interim services will simply collapse as they will face a tax burden far heavier than any employee yet be explicitly and deliberately excluded from any of the employment law benefits accruing to employees of the engager. There is unlikely to be any impact on the individual’s entitlement to NICs dependent benefits since they will already have a contributions record via their PSC.
ACCA is puzzled by the apparent contradiction between the government’s avowed support for small business and praise for the highly skilled, adaptable and mobile workforce that the UK economy is able to call upon, and these proposals which will act as a huge disincentive for the most able managers to share their services between a range of businesses, crippling the very responsiveness which has been hailed as fundamental to the agility and responsiveness of UK business.
Given that the policy aim is to ensure that controlling persons are correctly meeting their tax obligations, and that engagers have an assurance that this is the case, ACCA would suggest that rather than implementing the hugely disruptive proposal to create an entire new structure of PAYE withholding, the same aim could be achieved by imposing a reporting obligation on engagers and controlling persons to notify HMRC of any controlling persons contracts which are implemented. Details of the contracts could then be incorporated into the existing IR35 risk profiling process, with all parties knowing that this will be the case. The enforcement of the tax legislation upon the service providers will then be left to HMRC rather than the engager, without the risk that those individuals who should not on any other analysis be subjected to taxation as an employee are not subjected to withholding of PAYE unnecessarily.
Consultation questions
Q1. Is creating a provision which would require the engaging organisation to deduct income tax and National Insurance at source a correct and proportionate solution to this problem?
No. Considerable emphasis is placed in the Minister’s introduction on the importance of individuals meeting their tax obligations. This is further developed in the Executive Summary, in particular at Para 1.2, where the specific issue of disguised employment is identified. The individuals concerned are avoiding their existing tax obligations. The liability to tax already exists, but the issue is ensuring that the tax is correctly accounted for.
A fundamental concern is that the proposed measures could create new obligations which would not otherwise exist. If the controlling persons who are the target of this legislation are disguising their status for tax purposes as employees, then it is correct that their income from the engagement should be subjected to tax as employment income. However, if the legislation acted to inflict employment taxes upon individuals who would not on any other analysis be a disguised employee then this would represent an apparently otherwise unwarranted extension of the tax regime.
ACCA does not believe that it is the intention of these proposals to impose employee taxes on individuals who are not disguised employees. It is not clear that there would be any policy justification for extending the benefit of employee NICs to them – in most cases, the individual will in any event have a full employee NICs contribution record from their PSC or employer, and they do not appear to fall within one of the otherwise potentially disadvantaged groups in respect of whom deeming provisions are typically enacted. There is equally no justification made out in the consultation document for seeking to impose employee tax rates on those who are not employees. The existing legislation provides for recovery of taxes on the full cost to the engager as though the sums had been expended on an employee rather than a trading relationship, and moving to a model where employer NICs could be retrospectively added on to the existing contractual value would introduce an economic distortion which would gift the Exchequer 12.8% (at current rates) of the value to the engager of the provided services.
If services are bought in from an external supplier, the distinction between a controlling person contract, which will automatically impose full employee taxes upon the individual concerned, and any other interim management contract, will be crucial to the parties. An incorrect categorisation of the role will have significant implications for all parties, yet in what is already acknowledged to be a complex area of tax law these proposals would impose an additional new categorisation for all the parties to consider. Crucially, the contract would need to be correctly categorised in advance of the duties being performed, radically changing the whole recruitment/tendering process. While this may be a welcome discipline in those parts of the public sector which have historically struggled with the distinction between consultancy, program management, interim management and apparently full time management (as identified in the 2010 ACCA report 'Management Consultants and Public Sector Transformation') it is a wholly disproportionate response for those businesses which have not historically had the same difficulties with avoidance or evasion by their contractors.
Imposing deduction at source on sums paid in respect of an individual’s services where they have ‘control’ will impose a number of commercial and administrative burdens on engagers as set out below, but will provide no Exchequer benefit that could not already be achieved by other means.
Q2. Does the proposed provision raise any commercial, employment or other issues that would need to be considered before any final conclusions are reached? If yes, please advise.
ACCA has concerns that the interaction with the PAYE system will introduce unnecessary complexity into the new RTI system, and corresponding interactions with NPS. The consultation document seems to indicate that payments may still be made to an individual’s PSC, but would be subject to withholding of tax and NICs on behalf of the individual personally. In order for NPS to correctly allocate payments it will need details of the precise amount paid in respect of the individual’s services as a controlling person. The same would of course hold true if payments were to be made to another intermediary, such as an agency or large consultancy.
Although the Impact Assessment suggests that only a small number of individuals might be affected, ACCA is concerned that those few individuals might have a disproportionately large effect on the wider economy. The class of entrepreneurs who might be described as ‘serial turnaround specialists’ is numerically tiny. The skills they display are highly specialised and very few individuals have either the desire or the ability to take on successive challenges for a comparatively short term and specifically with a view to making a rapid return before moving on to a fresh challenge. However, they perform a key role in preserving employment for others, and safeguarding pockets of local economy. A measure which effectively destroys their business model would have far reaching and damaging effects upon the wider economy, as they would either leave the UK or move to other less productive roles.
Large consultancy firms in particular could pose significant challenges for this legislation. The dividing line where services have been outsourced or large projects are controlled by an outside consultancy may be difficult to draw, but ensuring that the legislation applies to all situations where opportunities for abuse exist would be essential to avoid undermining its effectiveness. However, there may be significant practical and commercial obstacles to identifying particular elements of the contract price as relating to ‘controlling persons’ activities. In a situation where a contract with a large consultancy is deemed to involve a ‘controlling person’ element, the individual who is subject to the provisions will potentially receive personally all the payments made in respect of their services, although after tax and NICs. Since this individual will also be in receipt of a salary from their direct employer, the consultancy firm, this may lead to a number of practical and commercial difficulties. It may be that the individual undertakes to surrender all such payments to their employer, or account for the set off in some other manner. Again the issue of double taxation arises.
A further complication arises in the case of engagements whose character changes. It is recognised in case law that the status of a previously independent contractor can move to that of a hypothetical employee, and hence within the ambit of IR35, during the currency of a contract. In the case of payments under IR35 this simply requires the PSC to adjust its payments of tax, at a time and in a manner which does not introduce significant commercial uncertainty, or necessarily expose the parties to penalties for failure to make correct returns.
Under the current proposals for withholding of tax, the parties would need to include contractual provision for the engager to withhold taxes from the payments to the PSC, or be faced with paying tax and NICs on the grossed up amount. In either case the PSC would need a reporting mechanism to avoid double taxation of the income when it is extracted from the company. Difficulties would arise whether a contract moved into the provisions, due to an increase in control levels, or out of it as budgets were reallocated, or workforces changed in size and composition.
The alternative, to require all payments to be made to individuals directly, would radically change the landscape for consultancy services in the UK. It would leave no scope for flexibility or responsiveness to changing situations. Existing contracts would need to be revisited. The key benefit of ‘troubleshooter’ management in problem situations, their independence, would be destroyed. Engagers would potentially be faced with managing the interaction with the Agency Regulations, once the legal ramifications of payment to an individual in respect of contractual arrangements with a third party (or through a chain of third parties) had been established.
Q3. Are there alternative approaches that would better deliver the transparency the Government is seeking in the taxation of controlling persons than requiring them to have income tax and National Insurance deducted at source by the engaging organisation?
Yes. Transparency is about knowing things have been done, rather than necessarily doing them for yourself. It is in any event unclear that private sector business has a significant concern with the tax obligations of their suppliers. Rather than setting up a withholding mechanism which, as set out above, could impose significant costs and complexity for little or no added value for any of the stakeholders, ACCA would propose a reporting mechanism which highlights to all concerned the importance of correctly self-assessing tax without disturbing existing guidance, procedures or legislation, perhaps modelled upon the existing return regime under s16 TMA 1970.
On entering into a contract for services which might give rise to a ‘controlling person’ scenario, the engager would inform the contractor of the qualifying nature of the contract, and make a return to HMRC identifying the individual and the contract, giving an indication of expected turnover under that contract. HMRC would then be able to run their own risk assessment on the individual, and if the individual did not return PAYE income sufficient to ‘frank’ any controlling persons contracts in the year then this would indicate grounds for investigation.
The emphasis is upon correct self-assessment of tax by the individual. If they manage their affairs appropriately then although they may be at significant risk of investigation should their analysis differ from what HMRC might consider typical, they will be aware of this and should have the relevant information readily to hand. The individuals who might be subject to this regime would by definition be commercially aware and able to identify and analyse tax risk amongst other commercial factors. The uncertainty which afflicts many of those potentially subject to the existing IR35 regime might be of less concern since it would be reasonable to assume that those affected would appreciate the importance of taking expert advice to mitigate risk in areas of uncertainty.
Q4. What are the consequences of this provision taking precedence over IR35 (Part 2 Chapter 8 ITEPA 2003) Part 2 Chapter 7 ITEPA 2003 and all extra statutory provisions?
ACCA assumes that the equivalent NICs provisions would also be affected. ESC A37 would be restricted in application only to officers who are definitely not controlling persons, eg auditors.
Q5. Are there any circumstances where this measure would prevent genuine commercial arrangements? If yes please explain.
As discussed above, ACCA is concerned that where contracts for project management or provision of outsourced services include services which may fall within the definition of controlling persons it will prove impossible for the parties to agree financial terms. The difference between gross and net payment amounts, and the possible requirement to name individuals and put a fixed price on their contribution to the project, would require a significant change to the way such contracts are priced and negotiated, together with provisions to cope with possible changes in circumstances during the currency of contracts or projects.
Q6. Is someone who has managerial control over a significant proportion of the workforce and/or control over a significant proportion of the organisations budget the correct delineation for a ‘controlling person’?
Q7. Should we extend controlling person to bring a larger group within the remit of this provision? If so who and why?
Q8. Should controlling person be narrowed so that fewer people are within its remit? If so who should be additionally excluded and why?
As the criteria for making a binary choice between two radically different methods of taxation the definition is far too vague. The immediate impact on both engager and individual would be such as to make the distinction one of key importance for both parties, but in marginal cases the financial interests of both parties would be better served by classification as non-controlling.
If the regime were to be introduced then ACCA would consider a 12 month grace period during which the provisions would not be applied to a contract to be a welcome modification. The majority of contracts for less than that period are likely to be true interim contracts which would not meet the tests for employment. It would be equally valuable to set strict numerical limits on values of financial control, or proportions of headcount which might fall within the regime. Although there is as always the risk that arrangements might be tailored to match the limits, the alternative lack of certainty would be far more damaging to the economy as a whole.
There is a significant risk that years spent arguing about the definition before the Tribunals could harm the Exchequer, both directly in legal costs and indirectly in opportunity cost of wasted resource, far more than the original purported tax loss might ever have been. Meanwhile, HMRC would be able to unearth examples of incorrectly taxed contracts only through the proposed extra compliance program, which seems of debatable value when the same impact on engager and contractor behaviour can be achieved through mandatory reporting to the existing IR35 unit of contracts which may be affected and are hence ‘high risk’.
ACCA does not see any merit in introducing a whole new class of worker for tax purposes in a climate where simplification is a primary driver for reform of the system given that tools already exist to identify and correctly tax all those who might be caught by the proposals.
Q9. Is this exclusion a proportionate exception to the proposed provision?
Q10. Is there any reason we should not exclude micro businesses, who are not part of a group structure from this provision?
ACCA is concerned that if the definition of ‘group structure’ is not sufficiently broad and clear then there will be a temptation for engagers who are determined to minimise the impact of the legislation to create structures which enable individuals to provide their services to a micro business which falls outside the existing definitions of ‘group’ for tax purposes rather than to larger organisations.