‘Unacceptable’ – departments scolded over costly IR35 failures

Written by Beckie Smith and Sam Trendall on 26 May 2022 in News

Parliamentary committee finds that government bodies have struggled to comply with tax reforms – which have long been unpopular with IT contractors

Credit: Philip Ingham/CC BY-ND 2.0

In light of some public bodies being forced to pay out hundreds of millions of pounds in back taxes, a committee of MPs has found that departments’ failure to comply with rules to crack down on tax dodging is “unacceptable”.

In 2020/21, central government departments owed or expected to owe HM Revenue and Customs £263m in back taxes even though they “should be best placed” to understand the tax agency’s IR35 rules, the Public Accounts Committee said in a scathing report published this week.

But MPs also levelled much of their ire at HMRC, saying the reforms were “rushed” and a lack of data makes it hard for organisations to assess the tax status of people they are hiring.

The IR35 legislation was introduced in 2000 to prevent contractors who work in the same way as employees from dodging tax. It was intended to stop so-called “disguised employees” whose duties are indistinguishable from those of a salaried staff member – but who avoid income tax and National Insurance contributions by working through an intermediary such as a personal service company.

Reforms in 2017 made public sector employers responsible for determining workers’ tax status to ensure the right tax is paid. The rules were extended to the private and third sectors last year.

These measures have caused particular disquiet among IT contractors – a significant proportion of whom make their living delivering services via short-term engagements and under the banner of their own registered company. The additional burden on public bodies and – in particular – businesses to ascertain and classify the tax status of temporary workers has seen some organisations place a wholesale embargo on the use of tech contractors. Others have tried to avoid additional complexity by treating all contractors as being subject to IR35 rules – regardless of their status.

When the rules were first introduced for public bodies in 2017, trade bodies representing freelancers and contractors warned that government could face "mass exodus" of technology experts retained by departments.

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PAC said there are still serious “structural problems” with the rules that HMRC has not addressed.

The high levels of non-compliance with the legislation among government bodies partly reflects “poor implementation” by HMRC, the committee said.

“[Non-compliance] 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 the reforms were rushed in by HMRC and public bodies were given little time to prepare – in particular, they had only two months or less with HMRC’s new guidance and tools before the new rules came into effect,” the report said.

Among other things, employers cannot always access information they need to accurately determine the tax status of someone they are hiring, and a lack of an independent appeals process means it is difficult for workers to challenge incorrect determinations about their status.

This lack of data means that if private contractors or the companies they work for reclaim the taxes they have already paid, the government could end up subsidising contractors for all of their tax, the report said.

This means departments are spending hundreds of millions of pounds to cover tax owed for individuals wrongly assessed as self-employed.

In December, the Ministry of Justice and the Department for Environment, Food and Rural Affairs had been hit with a combined £120m tax bill after failing to follow the rules.

HMRC also slapped the MoJ with a £15m fine for its “careless” application of off-payroll working rules from 2017 to 2020.

The Department for Work and Pensions has previously been hit with a tax bill of £89.7m related to IR35, while the Home Office last year had to cough up £29.5m – plus a £4m penalty for being careless.

'Unintended consequences'
It is now up to HMRC to estimate the extent of non-compliance with the rules across the public sector – and to identify areas where it can make the reforms easier to follow, PAC said. This could mean improving its guidance and tools, for example.

And the tax agency must “demonstrate the system can operate effectively and fairly in the real world, and investigate whether the costs and unintended consequences are proportionate to the additional tax revenue which the reforms raise”, the report added.

It must also carry out and publish research on the impact of IR35 on contractors and labour markets, and produce a cost-benefit analysis of the reforms reflecting the actual cost of compliance for HMRC, employers and contractors.

The government introduced the reforms because it considered it too costly for HMRC to oversee compliance effectively, and that hiring organisations could administer the rules for less cost.

But “many” public bodies have reported that the rules have caused problems for them recruiting contractors, the report said. 

HMRC has “done little to understand the wider impact of the reforms on workers or labour markets” and “underestimated the additional costs of implementing the reforms to hiring organisations”, it added.

Other recommendations for HMRC in the report included making it easier for contractors to challenge wrong determinations of their tax status, and proactively working with sectors that have been particularly affected to understand the challenges and address them.


About the author

Beckie Smith is deputy editor for PublicTechnlogy sister publication Civil Service World, where a version of this story first appeared. She tweets as @beckie__smith.

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