The Challenges of Taxing Employment (II) False Self-Employment

A consistent focus of UK Governments stretching back to, materially, Roman times has been an avowed desire to ‘clamp down on  false self employment’. Last week the Social Security Advisory Committee released a report identifying this as a phenomenon which:

occurs where employers (re)define their employees as being self-employed, which would not be appropriate if they effectively work for the ‘employer’.

This followed hot on the heels of the Consultation Document on the Onshore Employment Intermediaries provisions (“OEI”) in the Finance Act 2014. In his foreword, David Gauke, then Exchequer Secretary to the Treasury, said:

1.5 There are many legitimate reasons why a worker is engaged on a self-employed basis. The Government strongly supports enterprise and welcomes the contribution these entrepreneurs make to the economy. They recognise the additional financial risks someone who is genuinely self-employed takes and believe this should be recognised in the tax system.

1.6. However, there are times when someone who should be an employee is engaged on a self-employed basis. There are a number of benefits of engaging someone on a self-employed basis to the engager. The engager does not have to pay 13.8 per cent employer NICs and has none of the other costs associated with being an employer, including those associated with employment rights such as pensions contributions, redundancy pay and sick pay. The worker may benefit from a small increase in pay in the short term but this is at the expense of longer term benefits and protections such as employment rights.

And in 2009 the last Labour Government consulted on proposals which described the problem thus:

1.2 False self-employment occurs where workers are treated as self-employed for income tax and National Insurance (NICs) despite the fact that the way in which the work is carried out on a day to day basis demonstrates that there is an employment relationship.

And this Labour opposition has pledged, should it regain government in 2015, to introduce proposals similar to those it consulted on in 2009. And it’s not exactly as if the current legislative code ignores the issue. The Income Tax (Earnings and Pensions) Act 2003 contains (in addition to the Agency rules  revised in the Finance Act 2014) so-called ‘IR35’ provisions and ‘Managed service company’ provisions.


Because the line separating employment and self-employment is “blurred and shorn of logic and economic principle“; because the difference in tax rates (for those who recognise a rose by other names) is huge; and because there is fiscal advantage for both workers and engagers (to adopt two neutral expressions) in classing workers as self-employed, there is every incentive to arrange matters so that that which might be the one is taxed as the other.

Even so. That one might need (presently) three – and with a contemplated fourth – sets of statutory provisions to tackle a single issue might cause even us benighted professionals plying our trades in the field of tax to raise a wearied eye. How has this come about? And does the contemplated fourth provide reason to cast off the pessimism of experience?

An informed walk through the story above reveals three discrete but related issues.

First, there is a remarkable lack of clarity about the problem. None of the papers referred to above define (or define better than the quoted paragraphs) what false self employment is. Now, it is undoubtedly true that there are some workers who are wrongly treated for tax purposes by their engagers as self-employed when they are employed. But that is not a problem that requires legislative solution: the Tax Tribunal is perfectly able to address it without recourse to any of the provisions set out above. All the Tribunal need do is ask whether the worker is employed or self-employed.

The real problem (in this context) with the Tax Tribunal – as we know but do not say – is that the assessment of a worker as employed or self-employed is a fact rich one. In consequence, it is usually disproportionately (compared with the value of the arbitrage) resource intensive for HMRC to tackle the question worker by worker. The legislative solution that is offered is to substitute a less fact rich assessment. But this is, of course, a solution to a different problem (resourcing rather than wrongly characterisation). And these solutions create a different issue: that of false employment.

Take the on-shore intermediaries provisions, for example. They eschew the multi-factorial assessment of the Tax Tribunal for a focus on a single question, that of supervision, direction or control. Fail this and you’re deemed to be – and taxed as – an employee. Even if, having regard to all the relevant features, you would be deemed to be self-employed.

Second, there is, as I have stated above, a lack of clarity about the reasons for the difference in tax treatment between these categories of employed and self-employed. None of the papers cited advance beyond David Gauke’s rather imprecise observation about ‘risk-taking’. The tax code pays no mind to the differences between dynamic and steady state businesses; between those where capital is and capital is not being risked; and between those who do and do not employ. It has no regard at all to the huge value for the economy as a whole of having a flexible labour market. It’s a difference likely without any – and certainly without any articulated – rationale.

What the papers referred to above also reveal is a (largely unspoken) frustration with the fact that it is often possible to toggle the tax status of a worker through adjustments to the drafting of his or her contract. That workers in economically similar situations might be taxed so differently (with distortive effects on the ability of engagers to compete on price) might seem surprising. But it is a natural – indeed, it is an inevitable – consequence of the fact that the relationship of employment – and hence the incidence of taxation – is a function of contractual terms.

Third, there is an apparent lack of understanding about how the problem should in practice be tackled.

The OEI provisions contain an excellent example of such a short-coming. It’s all very well creating a liability to tax on a person. But this is meaningless unless you can in practice collect it. These provisions (immaterial exceptions aside) put the liability on a third party – neither the engager nor the worker. And they create a situation where both engager and worker are largely indifferent to whether that third party meets its liability. We – taxpayers at large – have long and bitter experience of such circumstances. The practical reality is that the third party too – invariably a barely capitalised corporate – will itself be indifferent as to its liability. Its owners will remove its income, let the corporate fail, and then (in a practice known as ‘phoenixing’) simply create another corporate.

Let me look at these issues in turn.

If one was honest about the real problem one was seeking to tackle – the problem shared by both HMRC and engagers of how to form a secure view of status – one might then more readily move to a sensible discussion of what fit-for-purpose legislative solutions looked like. But so long we pretend that the problem is otherwise, we remain handicapped in our ability to tackle it.

If we were clearer about the behaviour we wished to encourage through the differential in the rates between employment and self-employment we could more readily tax to encourage or reward that behaviour. At the moment it is difficult to discern a rationale beyond discouraging the contractual status of employment. And this – to me at least – feels like no rationale at all.

What is it that we really wish to encourage – surely it is not everything that is not employment? Might it be businesses that risk capital? Is it those that employ others? Is it businesses that seek to grow – as opposed to those that seek merely to remain in a steady state? Is it those who are prepared to commit to short term contracts to provide supply chain flexibility for their clients?

Legislators, compelled to avert their eyes from such considerations, are left to tinker about with aspects of the contractual definition of employment. This impedes their ability fiscally to grease the right economic cogs. Indeed, I would go further. It is – in my opinion – very likely but quite inadvertently to have the effect of removing fiscal incentives from behaviour that, clear-sighted, we would undoubtedly wish to encourage in our economy.

And as to the third? Beats me. If you have the answer, do let me know. Certainly shooting from the hip at politically expedient targets can dis-incentivise business from engaging in developing workable solutions.

I should note, finally, that I will return to consider the role of intermediaries in the labour market in more detail in a later post. For now it is enough for me to note that they are a feature of this landscape but not one that alters the analysis set out above.

Mixing tax and politics

A small bird – one who wants this project to succeed – informed me this morning of a concern that my Primer on the Conservative’s proposed rise in the personal allowance was perceived as too political.  I also know very well that my pieces on Labour and Tax Avoidance during its party conference were unwelcome (or perhaps more accurately, unwelcome to some). I tackled UKIP’s WAG (weekend fling?) tax. And I shall strive to find something of interest to say on Liberal Democrat announcements in the fiscal sphere.

But how consistent is this with my avowed intention to be apolitical?

There’s no escaping the fact that tax has a political dimension. Many of the big questions that divide right and left – the size of the State or the prioritising of relative and absolute wealth – are readily examined through a fiscal lens. Are taxes the price we pay for a civilised society or an undesirable confiscation of private wealth? Is progressivity in the tax system an absolute end – one to be pursued even at the cost of economic growth?

So close is the relationship between tax and politics that I shall propose a challenge. There is, in any plausible world, no tax decision that one fellow Waiter can propose that another Waiter will not be able to badge as inherently political. Give it a try (it’s my neck on the line, after all).

Of course, the concerns are of a different nature. There I am, wading into party politics, at this most tribal of moments. Surely that is political in a meaningfully different way?

It is, of course.

But that doesn’t mean that to tackle such stuff is to cease to be apolitical. I think it’s entirely proper to point out the distributional effects of particular tax measures. If the Conservatives find that embarrassing, that’s their problem: adopt a different policy. Qualitatively the same, in my view, is pointing out some arithmetical questions arising from Labour’s pledge to fish another £650m out of a rather dry looking pool. The problem isn’t that I’ve pointed it out.

Improving the quality of public and political debate around tax“: I can’t pretend to be aiming for that without doing my best, with my available time and limited skills, to point out where it seems to me that what we’re being told by politicians doesn’t stack up. Should I be backing off because of the time of the political day? Absolutely not: now is the moment it matters most.

 

A small postscript. I’m slightly embarrassed about the amount of inward looking stuff here. I wanted to say this: it’s important to me. But next week we’ll be back to the real stuff. Promise.

 

 

 

 

A £12,500 personal allowance: a primer

Raising the personal allowance has been a key fiscal policy objective of the coalition. David Cameron has just announced a future Conservative Government would raise it from £10,500 (to be introduced in 2015-16) to £12,500. What might this cost, who will benefit, and who is it targeted at?

The cost:

Here are some very rough back of the envelope calculations. When, in Budget 2014, the Coalition announced the raise to £10,500 (from, assume, £10,000), this was forecast to cost an average of £1.75bn pa over each of the next four years. Multiply that by, roughly, four (if 500 costs £1.75b than 2000 all things being equal will cost four times as much) gives you £7bn pa – but of course you then have to factor in the fact that as the personal allowance increases the number of people able to take advantage of that increase declines (because they earn less than the increased allowance). About (these percentage figures only cover people with some liability to income tax) 11% of people earn below £10,500 and about 21% below £12,500. And that fact is a rather telling one – I’ll come back to it.

Who benefits:

The first thing to note is that it only benefit those earning more than £10,500.

If you work part-time, or you’re self-employed, or you work on a zero-hours contract you may well benefit not at all. Self-evidently, if you don’t have taxable earnings – because for example you’re reliant on benefits – the increase will do nothing for you.

What about those on the minimum wage? £6.50 per hour x a 35 hour week gives you a weekly taxable income of £227.50 or an annual income of £11,830. So if you earn minimum wage, you’ll benefit. Somewhat. To the tune of £266 per annum post tax. Those earning the median wage (something around £520 pw), on the other hand, will benefit by £400 pa. (These figures assume that there are not corresponding rises in national insurance contributions thresholds – although past practice suggests there will be).

Who is it targeted at?

The short answer is, not the lowest paid. If you wanted to help only those earning minimum wage, you could certainly do so an awful lot more cheaply and an awful lot more generously than by this measure (which is likely, depending on the detail, to benefit everyone earning below £100,000).

Remember that when you hear a politician say, in response to the question: ‘What have you done to lift people out of poverty?’ the answer ‘I raised the personal allowance to £12,500 and took a whole bunch of people out of personal income tax’.