We're all taxmen now

The recent consultation paper The Inland Revenue and the Construction Industry is the result of the government's examination of the construction industry scheme (CIS). It is designed to introduce reforms to reduce the regulatory burden on the industry and improve the level of tax compliance – a marriage of convenience, you might say.

The government instigated the review because of Inland Revenue concerns that the CIS scheme was not being operated correctly, and in many instances was subject to abuses. One criticism of the system is that when a subcontractor is engaged by a contractor, the contractor does not independently check that subcontractor's employment status on presentation of the registration card CIS4. Often the contractor merely assumes that the subcontractor is self-employed for tax purposes, when it is not.

Over the years the courts have examined the question as to exactly what constitutes employment and self-employment. Whether a subcontractor is employed or self-employed depends on whether the contract between the subcontractor and the contractor is one "of services" or "for services".

Although this may seem to be a play on words, these terms have specific legal meanings. A contract of services relates to a "master and servant" relationship that forms the basis of employment, whereas a contract for services is self-employment. To the layman, and indeed to many tax professionals, this distinction may not be at all clear, which is why there has been so much litigation in this area. In the case of Ready Mixed Concrete (South East) vs Minister of Pension in 1968, the court identified that where the worker provides its own tools and equipment, hires staff, has sole responsibility for its actions, takes a financial risk and has the opportunity to profit from sound management, then all these factors indicate that the contract between the parties is one for services.

The Inland Revenue, in its internal instructions to staff, has based its view on the constituent parts of self-employment around the case of Barnet vs Brabyn (1996), which uses the law in a highly selective way and seems to ignore cases that have been decided in the taxpayer's favour, such as BSM (1257) vs Secretary of State for Social Services, which, in 1978, held that driving instructors were self-employed. Consequently there is no guarantee that the Inland Revenue will agree with a contractor that a particular subcontractor is self-employed. This may well lead to further litigation in the future.

The new verification process identified in the consultation paper requires the contractor to notify the Inland Revenue of the name and National Insurance number of the prospective subcontractor and to consider its employment status. The consideration of the employment status is not a new requirement since under the existing scheme, the contractor must operate the PAYE system if the subcontractor is merely an employee. However, under the proposed scheme, it is a requirement that the contractor sign a declaration that the status of the subcontractor has been considered and, should a false declaration be made, then penalties will be imposed on the contractor. It is not clear from the consultation document whether genuine mistakes as to the tax status of the subcontractor will be treated as a false declaration or whether the Inland Revenue will only penalise negligence or wilful default.

The consultation document states that although the Inland Revenue recognises that the costs of complying with the verification process will increase, taken as a whole, the measures proposed are meant to reduce costs of compliance with the CIS rules. Whether this is so or not remains to be seen.

One thing is clear, however: the Inland Revenue is once again shifting the burden of policing tax collection to the taxpayer and can only benefit from the application of the new scheme for dealing with non-compliant contractors and subcontractors. Inevitably, the new penalty regime for contractor declarations will be seen by some within the industry as draconian.