The cross-party Public Accounts Committee (PAC) has published a scathing report, heavily criticising HMRC over its handling of the public sector IR35 off-payroll reform which came into effect in April 2017. Danny Batey, senior tax consultant at Markel Tax, talks through the details.
Five years on, the PAC’s comprehensive report sets out six conclusions, including recommendations for HMRC to action, which we will consider in this article. There is also the expectation that HMRC provide an update to the PAC on these recommendations. The hope being that lessons are learned that make a positive impact on both the public and private sectors moving forward.
High levels of non-compliance
The roll-out of the off-payroll rules has caused widespread confusion and, in some cases, high levels of non-compliance across central government departments and agencies. Underlined by the fact that certain departments have been found to have incorrectly administered the rules – ironically including HM Courts & Tribunals Service, the ultimate arbiters of IR35 – resulting in a combined tax and NIC liability owed to HMRC to the tune of £263 million for tax year 2020/21.
The PAC’s concern is that this may only be the tip of the iceberg with likely more departments also failing in their responsibilities, but who are yet to face a compliance check by HMRC.
The report takes aim, blaming HMRC for its poor implementation of the rules, stating: “This is not acceptable considering government departments should be in a good place to understand the rules and communicate with HMRC. However, mistakes were likely as reforms were rushed in by HMRC and public bodies were given little time to prepare”.
The support offered by HMRC clearly fell below the required levels necessary to make the roll-out a success, especially within such a short timeframe. As many industry experts had pointed out to HMRC at the time, issuing a raft of technical guidance, including their Check Employment Status Tool (CEST), approximately two months prior to roll-out, left many government departments ill-prepared, meaning challenges were almost certainly to be expected.
As a result, the PAC have recommended that HMRC develop robust estimates of non-compliance for the public sector to identify areas where compliance can be improved, including its own guidance and CEST tool.
Disagreement process not fit for purpose
The PAC stated that they “…are concerned that it is too difficult for workers to challenge incorrect status determinations”.
We also share similar concerns from our own experience of assisting contractors through client-led disagreement processes. Often clients are unwilling to deviate from their initial assessment, choosing to ignore any technical submission or additional factual evidence presented by the worker, in an attempt to overturn the client’s decision.
This risk-averse approach has been typically adopted because of the potential for clients facing liabilities of tax and NIC that would become due should any ‘outside IR35’ opinion be successfully challenged by HMRC. Under the current regime, clients are essentially marking their own homework with very little incentive to overturn their decisions given the level of liability involved, which have already been witnessed in the public sector.
Where the client has followed the correct disagreement process and an ‘inside IR35’ decision is confirmed, the contractor has no further recourse other than to seek a refund of tax and NIC through their self-assessment return. However, as the PAC pointed out in relation to seeking such a refund: “It is unclear how effectively these routes operate in practice and the extent to which they are used, because HMRC does not monitor this”.
In order to improve matters, the PAC suggests that HMRC should ensure “…there is a fast and independent process to resolve disputes over status determinations” - a recommendation that would likely be welcomed by many contractors and their advisors.
Understanding the impact of the IR35 reform
The warning signs regarding the likely impact the reform would have on the contractor market in general were there long before actual implementation. Contractor groups, accountants and IR35 specialist tax advisers had repeatedly warned HMRC of the potential negative consequences.
HMRC do not accept the evidence that has been presented to them from those directly affected, describing references to blanket ‘inside IR35’ decisions and clients refusing to engage completely with contractors operating through their own limited company as ‘anecdotal’ evidence.
The PAC report suggests that HMRC “…are not doing enough to understand the impact of the reforms on workers and labour markets”. Their recommendation is that HMRC conduct and publish specific research into the impacts of the IR35 reform on contractors and labour markets to check if it is being applied as intended and not adversely affecting employment opportunities.
Furthermore, HMRC have been tasked with identifying those industries that may require additional and targeted support to help with off-payroll reform and to report this back to the PAC in six months. This request is made on the basis that currently the PAC “…is not confident that HMRC work proactively to establish whether any sectors have been affected disproportionately by the reform…”.
What is the true cost of the IR35 reform?
This is the key question, which, at the time of writing, HMRC are unable to answer with any real certainty. Instead, a figure reached by their own costs modelling, estimated a theoretical figure that clients would incur in the region of £35 a year per limited company contractor.
One assumes that this is solely based on 10 minutes spent completing the CEST tool. It is unclear how this in isolation is meant to establish reasonable care – the lack of which has no doubt led to fines being imposed on the public sector bodies.
In our opinion, a genuine understanding of the IR35 status of an engagement requires all of the following:
- an assessment of all the contracts in the contractual chain
- assessing the working by practices from input by both the engaging public sector body and the worker
- since April 2021 creating a reasoned Status Determination Statement (SDS) to issue to the worker and recruitment agency (if applicable)
- ensuring that there is not only oversight of this process, but systems in place to periodically review decisions
None of this takes into account that there will be so many different departments responsible for creating these roles, that there will be queries from hiring managers, misunderstandings and conflicts between engager and contractor opinions about the actual working practices. Nor any potential challenges via the client-led disagreement process.
Again, from our own experience - and supported by evidence provided by those parties directly affected - the low figure presented by HMRC is not in the ballpark of the true costs incurred and has been grossly underestimated.
HMRC claimed back in 2018 that reform has generated an additional £440 million from the public sector, and while no further updated figure has been supplied, it feels like this figure may have been overstated and doesn’t necessarily reflect the true cost of compliance. The main reason for this could be that many contractors are now paying incorrect levels of tax and NIC, i.e., too much tax an NIC, on the basis they have either been incorrectly assessed as being ‘inside IR35’ or they have been forced onto PAYE or to operate via an umbrella company. These being the only options given by their public sector client should they wish to continue working on their engagement.
The PAC has asked HMRC to” present to Parliament a cost benefit analysis of the reforms that reflects the actual costs of compliance to HMRC itself, hiring organisations, workers and others in the supply chain”.
Despite reform, structural problems still exist
The report identifies the difficulties that clients and contractors are facing following reform implementation with the PAC specifically stating: “The IR35 rules do not work well with the realities of contracting, in both determining workers’ tax status and in resolving issues when mistakes have been made”.
The report established that public sector bodies often do not have access to all of the necessary information specifically relating to the client’s organisation, which would be needed to provide accurate IR35 assessments.
Another concern, which HMRC have been aware of for some time, is that the current legislative framework does not allow tax and NIC liabilities to be offset against tax and NIC already paid, leading to double taxation.
The PAC comments that “this position does not look sustainable and risks being more costly to all parties the longer it goes on” and therefore suggests HMRC develop solutions to address the issues with how the IR35 legislation works in practice by ensuring that it collects the necessary data to enable it to assess a workers tax position in cases of non-compliance and that income is not taxed twice or contributing to workers not paying their fair share of tax.
Where do HMRC go from here?
Time will tell whether HMRC will be prepared to fully take on board the PAC’s recommendations and it will be interesting to see what feedback they provide in six months’ time as requested.
To summarise, specifically the Committee wants HMRC to:
- Develop robust estimates of public sector non-compliance to identify where HMRC can reduce the inherent compliance challenges, e.g., improving guidance and tools. It expects HMRC to adopt a similar approach for the private sector as the reforms bed in and write to the PSC with an update in six months.
- Ensure a fast and independent process for contractors to resolve status determinations disputes exists. HMRC should assess the extent to which workers are using existing appeals routes and their effectiveness.
- Conduct and publish specific research into the impacts of the IR35 reform on contractors and labour markets, to check its application is as intended and not adversely affecting employment opportunities.
- Proactively identify and work with sectors that have been particularly affected to understand the challenges, establish how to address them and make it easier to comply – and again, write to the PAC in six months with an update of the outcome of this public engagement.
- Produce and present to Parliament a cost-benefit analysis of the reforms reflecting the actual costs of compliance to HMRC, hiring organisations, workers, and others in the supply chain.
- Review how the system is working: can it be made more efficient and effective? In particular, HMRC should develop solutions for problems with how the practical operation of the IR35 rules, including ensuring that:
- HMRC have the data it needs to accurately reflect each worker’s tax position in cases of non-compliance; and
- HMRC do not end up taxing the same income twice, or unwittingly contributing to workers not paying their fair share in tax.
However, if HMRC’s past track record of engagement, following previous PAC reviews, and the comprehensive House of Lords report on the off-payroll legislation is anything to go by, positive change seems unlikely. We also expect that those contractors providing services in the private sector will be very keen to see the outcome of this review, given the similar issues that have been faced over the last 18 months from when the off-payroll legislation was brought in. Watch this space.
Click here to learn more about IR35 and how to determine your IR35 status.