A tax law blamed for adding stress and expense to the lives of freelance IT contractors should be suspended and possibly abolished, a Treasury body said yesterday.
The IR35 tax law was introduced in 2000 to address a loophole that allowed contractors to reduce their tax liability by providing services to businesses through a limited company.
A report by the Office of Tax Simplification (OTS) yesterday recommended that the government either suspends and later abolishes the IR35 law, keeps IR35 but improves the way it is administered by HM Revenue & Customs (HMRC) or introduces a simple test to see if contractors should make additional payments to HMRC under IR35.
The IR35 legislation requires certain contractors to pay the higher levels of tax and National Insurance Contributions (NIC) demanded of company employees. If a contracting organisation is deemed to fall under IR35, then general estimates are that it could pay up to 25 per cent more tax.
Criticisms of IR35 are that it is often difficult and time-consuming for contractors to determine whether individual contracts fall under IR35, and that contractors should not pay the same levels of tax as company employees because they do not receive the same benefits.
If the government were to suspend and then abolish IR35, the loss of its tax-avoiding deterrent could result in HMRC losing more than £200m in revenue each year, the report warns.
However, the OTS report recommends that the government should consider integrating income tax and NIC - a move it suggests would remove the incentive for contractors to set themselves up as companies to reduce their tax burden.
The alternative option suggested by OTS, of introducing a simplified business test to see whether contractors should face higher taxation under IR35, "would aim to reduce radically the size of the population potentially caught by the IR35 legislation and thereby remove a large number of contractors from the worry of a potential IR35".
The report was welcomed by the Professional Contractors Group (PCG) whose chairman, Chris Bryce, said in a statement: "Should the chancellor accept the recommendation to abolish IR35, this would be a major advance towards honesty, transparency and fairness for the freelance community.
"We now wait for the chancellor's decision on the merger of NIC and income tax, which will provide the basis for any reform."
Bryce continued: "We have been telling the government and all interested parties that IR35 was not fit for purpose. We now call on the chancellor to opt to suspend IR35 with the view of permanent abolition.
"This would remove a shadow that has hung over the UK freelance community for over a decade and be a massive vote of confidence in this skilled and flexible community."
He also backed the business test option suggested by the OTS, but warned that leaving IR35 unchanged with improved HMRC administration would be unacceptable to the PCG.
Chancellor George Osborne will consider the findings of the report and decide which of its recommendations to implement.
Nick Heath is chief reporter for TechRepublic. He writes about the technology that IT decision makers need to know about, and the latest happenings in the European tech scene.