Off-Payroll Working (Economic Affairs Committee Report)

Baroness Noakes Excerpts

Wednesday 27th April 2022 Grand Committee

[Baroness Noakes (Con)]

My Lords, my noble friend Lord Bridges has given us a masterly summary of the work of the Finance Bill Sub-Committee on off-payroll working, and I pay tribute to his chairmanship of the sub-committee’s latest look at off-payroll working. I agree with everything my noble friend said, in particular on CEST, which is widely regarded outside HMRC as unsatisfactory.

I was a member of the Finance Bill Sub-Committee for its latest update work, though not when the initial off-payroll working report was produced. I did, however, chair the Select Committee of your Lordships’ House on Personal Services Companies, which reported in 2014 and was the first time your Lordships’ House ventured into this difficult territory. When we prepared the 2014 report, we had a very unsatisfactory engagement with the Treasury, which flatly refused to provide either Ministers or officials to give evidence, and the Treasury response to our report was disappointing, to say the least. I concluded the debate on the report in your Lordships’ House by saying that the issues would not go away and that your Lordships’ House would return to them, and I am very grateful that the Finance Bill Sub-Committee has enabled the House to do just that. I am also pleased that the Treasury has engaged with the sub-committee this time—though that engagement does not mean, however, that the Government have fully engaged with the issues.

In principle, I support the Treasury’s efforts to ensure that tax is not avoided on earnings if they are, in truth, disguised employment; there is a genuine fairness issue here. Work which is identical and carried out in substantially the same circumstances should be taxed in the same way. The problem is that the solutions the Government have used do not achieve fairness in an holistic way, as my noble friend Lord Bridges has said. In particular, the latest set of actions that, in effect, outsource IR35 compliance to employers has produced a new form of unfairness—namely, the creation of a class of zero-rights employees. These are contractors who are not technically employees of the engaging employer but are brought on to the payroll for tax purposes. They pay tax as employees but have no rights as employees to such things as maternity pay, and this is most definitely not fair. The Government have allowed this to happen because they focus on tax yield at the expense of seeing the issues in the round.

It was good when the Government commissioned the Taylor report into modern working practices, but very disappointing that, since the report came out in 2017, it has been consigned to the long grass. The Financial Secretary’s latest letter to my noble friend Lord Bridges following the recent Finance Bill Sub-Committee’s work confirms that it remains solidly in the long grass.

The Government’s sole focus on collecting tax has also resulted in employers pushing workers into the use of umbrella companies, as my noble friend said. This avoids them taking those workers on to their own payrolls. As we heard, there has been a fivefold or sixfold increase in the number in the last 15 years, with 500,000 or 600,000 individuals working through umbrella companies. While there are some well-run and responsible umbrella companies, there are also some very bad ones, and there have been egregious cases of tax avoidance associated with them. Many of the workers in this category are low-paid workers, not the higher paid IT contractors; these are relatively low-level manual workers. These people have a relatively dim understanding of their worker entitlements and rights in any event, but they are pushed into this model. The Government’s priorities ought to be to ensure that they have appropriate employment rights and protections, but the Government have been focusing on tax collection and that alone.

The call for evidence last year was a belated attempt by the Government to wake up to the problems in this area, but I am not sure that I have confidence that there will be a good outcome from that. In other instances, employers have either declared that they will not hire contractors or have made blanket decisions that they will put all contractors on to the payroll for IR35 purposes. Some contractors have in turn decided that they will not work for those engagers, and we had evidence that some were now working from outside the UK in order to get away from IR35. The one thing that seems highly likely is that the off-payroll rules themselves have distorted the labour market and may well have diminished the prized flexibility of the UK labour market. The Finance Bill Sub-Committee has urged the Government to undertake research into the impact on the labour market, but I do not have high hopes that the research currently being undertaken will provide definitive answers, based on the Treasury’s response to the sub-committee.

The root of the problem is the foundations on which our tax system has been built. The UK taxes income according to its source and we treat income from employment and self-employment differently and, in particular, have made a conscious decision to tax unearned differently again. The tax system positively incentivises people to work on a self-employed basis and to seek to convert earned income into dividend income via service companies. The biggest distortions arise from the choices that have been made in the design of national insurance, including the new health and social care levy. These are taxes in all but name. There is a fairly big difference between the way in which employed versus self-employed people pay national insurance—the gap is three percentage points in the main national insurance rate—but there is a massive difference in employers’ national insurance contributions. It is now just over 15%, for which there is no equivalent for the self-employed. Therefore, employment income can attract a tax rate of 18 percentage points higher than self-employment income, and dividend income attracts no national insurance at all.

Last year, the Institute for Fiscal Studies published a study on taxing work and investment across legal forms. The clear finding was that the distinctions between different forms of income involved unproductive work in policing the boundaries. In particular, in relation to IR35 it said that this approach is failing, and will continue to fail, because it cannot overcome the core problem:

“there is no coherent principle underlying the distinction”

between legal forms.

A fundamental reform of the taxation of income, including national insurance, is now long overdue. It is the root cause of the problems with IR35 and the many types of unfairness that IR35 promulgates. I know that there are no easy solutions and that it will take a brave Chancellor to reorient the basics of our tax system, but equally there is no easy answer to the IR35 problem, as the past 20 years have shown. It is time for the Treasury to be bold.