In 2020-21, government departments and agencies owed £263m in additional tax for failing to administer the IR35 off-payroll working rules correctly, a government report has suggested.
According to the National Audit Office (NAO), the public sector faced challenges with the initial rollout of the off-payroll working reforms in 2017, including having little time to prepare and finding it difficult to use the original guidance and tool that HM Revenue & Customs (HMRC) provided to determine the true employment status of contractors.
There was also limited understanding of how much time and resource were needed to introduce the reforms smoothly. As a result, it was highly likely that some public bodies would make mistakes, the NAO finds.
The IR35 reforms have shifted the responsibility for determining a contractor’s employment status for tax purposes onto the organisation using their services, and are designed to stamp out improper use of personal service companies (PSCs) to avoid paying tax.
Last year they were introduced in the private and third sectors, and the NAO’s Investigation into the implementation of IR35 reforms report recognised that inherent differences between the public and private sectors would mean that HMRC would face further challenges in implementing the rules.
For example, HMRC estimates that the 2021 extension of the reforms will affect 180,000 personal service companies (PSCs) – almost four times the number affected by the 2017 public sector reforms.
This creates a “bigger challenge for HMRC to identify and monitor risks of non-compliance”, the NAO’s report says.
Complex supply chains are also more common, including those that cross international borders or involve overseas workers. This may mean a greater risk of companies making errors when determining tax status, it says.
The NAO also claims that HMRC’s compliance approach has not yet been tested for private and third sector companies. So far, it has only found central government bodies to be non-compliant, and none have challenged its determinations in court.
Questions also remain about the system for addressing incorrect employment status determinations and routes of appeal, the report adds.
It recommends that HMRC further develop its “check employment status for tax” (CEST) tool, which has in the past been plagued with inaccuracies. It should also update the guidance that accompanies the tool to make it as easy as possible to use accurately.
This should include:
- taking a structured approach to analysing sources of mistakes and user feedback to improve the questions and limit the scope for misinterpretation
- embedding or linking to relevant parts of the guidance within each question to make it easier for users to understand the questions
- ensuring there is a clear and efficient process for users to follow when CEST cannot provide a determination, including from HMRC’s own helpline.
It should also assess the usefulness of the CEST tool for different sectors, including where the risk of non-compliance may be greater.
Dave Chaplin, CEO of compliance firm IR35 Shield, said the report serves to “shine another bright spotlight on the flaws seeping through HMRC’s Check Employment Status Tool”.
“CEST has played a key role in the off-payroll debacle that has unfolded and the lack of guidance by HMRC did not help the public sector, evidence by the number of government departments that got off-payroll wrong.”
CEST has played a key role in the off-payroll debacle that has unfolded and the lack of guidance by HMRC did not help the public sector, evidence by the number of government departments that got off-payroll wrong.” – Dave Chaplin, IR35 Shield
The report also finds that HMRC’s current approach to correcting cases where status determinations in the public sector have been wrong results in it collecting more tax than is sue, but it does not yet have a plan to address this.
Once the non-compliant client organisation accepts that its determinations were incorrect, the workers become entitled to claim back the tax that they and their PSCs have already paid. If they do, they in effect pay no taxes on that income because these are borne in full by the non-compliant employer. However, HMRC does not actively promote this and it is unclear how many workers reclaim their taxes in practice, the report says.
“In essence, £263m was paid by a government body to another government body, and now all those contractors can reclaim their tax back, and pay no tax on their earnings – that would result in a loss of revenue as a result of their investigations,” Chaplin comments.
“Furthermore, given that firms’ decisions on status are not binding in law, there is nothing to stop a scurrilous contractor claiming the tax back by saying they were really inside IR35. What would HMRC do then? Would they refund them and pursue the client? Or would they fight the contractor in court? What a mess.”
Seb Maley, CEO at IR35 compliance firm QDOS, said: “This investigation is damning and exposes many of the gaping holes in HMRC’s plan for IR35 reform. It shows that public sector changes were rushed, the tax office’s IR35 tool [CEST] is deeply flawed and that contractors had next to no chance of appealing unfair IR35 status decisions.
“As far as I’m concerned, it asks all the right questions – a far more accurate reflection of the public sector experience compared to the recently published HMRC-commissioned research.
“Private sector businesses can learn a lot from this investigation. It makes clear that CEST should not be relied on to assess IR35 status and that HMRC has no hesitation in issuing staggering tax bills for non-compliance, evidenced by the £263m owed by public sector bodies.”