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Myths Could Hamper Sensible Reform, U.K. Tax Committee Says

Posted on July 27, 2020

Employment law and tax law have different policy objectives, and the solution to problems created by a poorly designed U.K. tax system is to fix the system’s foundations, tax specialists warned.

The lower rates of tax paid by the self-employed cannot be justified by what are now small differences in access to government benefits, and fairness “does not require the self-employed to get lower tax rates because they do not have employment rights,” according to a Tax Law Review Committee (TLRC) discussion paper published by the Institute for Fiscal Studies on July 22. Those rights are a transfer from employers to employees, and trying to compensate for them with lower taxes on the self-employed would require balancing through higher taxes on their engagers, the paper argued. 

Separately, the House of Commons Treasury Committee urged the government to rethink its position on the exclusion of more than 1 million people from coronavirus support schemes.

The TLRC paper’s coauthors — TLRC Chair Judith Freedman and Helen Miller, head of tax at the Institute for Fiscal Studies — said the policy aim should be to “bring levels of taxation and the tax base closer together” for all those who supply labor. They argued that employment status is an important concept in many areas of law, each of which serves different objectives and may need differences in definition. “Tax considerations should not distort employment law or inhibit any reforms to employment law. Similarly, employment law, or changes to employment law, should not distort taxation decisions or inhibit tax reforms,” they added.

Chancellor of the Exchequer Rishi Sunak said in March that if taxpayers want to benefit equally from state support in the future, “we must all pay in equally in future.” It was harder to justify “the inconsistent contributions between people of different employment statuses,” Sunak said when he announced details of the self-employment income support scheme.

The TLRC paper follows a July 17 webinar marking the launch of a Treasury Committee inquiry into “tax after coronavirus.” Participants discussed the “three-person problem” of people who do the same work but take home different amounts because one is employed, the second is self-employed, and the third works through a personal service company. Heather Self, a corporate tax partner at Blick Rothenberg and a member of the TLRC, asked the Treasury Committee to focus on the taxation of labor as an example of “a clear fault line in the tax system.”

Freedman and Miller noted that the House of Lords Finance Bill Subcommittee argued in April that the IR35 framework intended to counter disguised employment arrangements is flawed. The subcommittee urged the government to use a delay in implementation of IR35 reforms — now scheduled for April 2021 — to rethink its approach. While the TLRC “strongly supports” the peers’ call for a fundamental review, “it is the underlying system that is flawed,” they wrote.

The authors said “three persistent myths” could hamper sensible tax reform, leaving a system that “continues to create distortions, complexity, and unfairness.” It is a myth to believe that lower rates of tax for the self-employed are justified by reduced access to government benefits, and it is a “common misconception” that fairness requires the self-employed to get lower tax rates because they do not have employment rights, they said. The third myth is that "the employment law definition of employment status should provide the framework for tax treatment."

“IR35 was merely designed to plaster over cracks in the wall. If the cracks continue to appear, as they have done, that should tell us that the problem lies elsewhere, in the foundations,” according to the TLRC paper. The authors share the Taylor Review’s call in July 2017 for “a more consistent level of taxation on different forms of labor,” but do not agree that a single statutory definition of employment status for all purposes would improve the current situation. “If anything, [that would] increase distortions and the problems of the definitional cliff edge,” they argued.

“Having a separate framework for determining employment status for the purposes of employment rights and tax adds to confusion for individuals and employers, and can drive behavior detrimental to workers and more likely to result in noncompliance from a tax perspective,” the government said in “Good Work Plan,” a paper published by the Department for Business, Energy & Industrial Strategy in December 2018.

But the TLRC believes the fact that the self-employed have fewer employment rights than employees does not mean they should pay lower rates of tax. “The relationship between those providing labor or services and those using those services should be regulated by contract and statute. On the whole it is best not to distort commercial arrangements by tax considerations,” the authors said. "Even if it is desired to encourage or support certain working arrangements, a blanket tax relief for all ‘self-employed’ (which is bound to be a heterogeneous group, however defined) is not a well-targeted or effective way to achieve this."

MPs Urge Rethink on Gaps in Coronavirus Support Schemes

Sunak has “effectively drawn a line under helping the million-plus people who have been excluded” from the government’s coronavirus support schemes, Mel Stride, Treasury Committee chair and a Conservative member of Parliament, said in a July 23 release.

The committee published Sunak’s response to its June 15 report calling on the government to “find a practical solution to supporting hundreds of thousands of limited company directors who are missing out on support because they pay themselves in dividends.” (Prior coverage.)

“Targeting additional support for those who pay their wages via dividends is much more complex than existing income support schemes. Unlike announced support schemes, which use information HM Revenue & Customs already holds, it would require owner-managers to make a claim and submit information that HMRC could not efficiently or consistently verify to ensure payments were made to eligible companies for eligible activity,” Sunak said in a July 15 letter to Stride. "This is because, under current reporting mechanisms, it is not possible for HMRC to distinguish between dividends derived from an individual’s own company and dividends from other sources. Nor is it possible to distinguish between dividends in lieu of employment income and as returns from other corporate activity."

“Despite stating that he will not pick winners and losers when it comes to sectors and businesses that need support, the chancellor has done this when it comes to households and individuals,” Stride said in response to the letter. “The chancellor said that the schemes were designed to be open and accessible to as many people as possible, but the committee remains to be convinced that more people could not have been helped. The chancellor initially told those at risk of losing their livelihoods that they would not be forgotten. While the government is clear that it is moving on to the next phase of its recovery plan, it cannot just turn its back on those who are suffering.”

The National Audit Office will examine the implementation of the coronavirus job retention scheme and the self-employment income support scheme, and will report to Parliament in the autumn. The review will consider how the schemes have been set up, whether they have reached the groups intended to benefit, and how HMRC is mitigating the risk of fraud in the schemes.

Compliance Work Brings ‘High Rates of Return’

HMRC’s work to improve taxpayers’ compliance with the tax system has achieved high rates of return, the National Audit Office said in a July 22 release alongside the watchdog’s report on the tax gap. At 4.7 percent, the 2018-2019 tax gap is the lowest on record, HMRC reported on July 9.

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