Damning report published of HMRC IR35 implementation failures

In a recently published report produced by the Public Accounts Committee (PAC) it appears that HMRC is considered to be at fault for the £263M liability that HMRC assessed on other Government departments and not, as HMRC would contend, the consequence of the various Government departments mistakes.

The report suggests that the errors found are due almost entirely because of HMRC’s rushed and generally poor implementation of the new rules.

The report appears scathing in its comments, implying that HMRC had failed to understand the wider impacts of the reforms, failed to make realistic cost assessments, and even now is not doing enough to understand the impact of the changes on businesses.

The reforms introduced into the public sector from April 2017 placed responsibility on the engaging organisation to assess whether the off-payroll rules applied to an engagement, fast forward to the 2020-21 tax year and it is apparent that many government departments have struggled to come to terms with the reforms resulting in underpayments of PAYE tax and Class 1 National Insurance Contributions totalling £millions being due to HMRC.

Such levels of non-compliance were considered unacceptable by the PAC, particularly as it should be reasonable to assume that government bodies should be better placed than most businesses to understand the rules and communicate effectively with HMRC in order to comply.

The report considers that the compliance issues are compounded because HMRC rushed the implementation of the reforms including providing poor guidance and public bodies struggling with HMRC’s Check Employment Status for Tax tool (CEST) to assess status. A comment that has been repeated in the private sector following the April 2021 extension into this sector.

Many public bodies report that the reforms have also caused significant problems for them in recruiting contractors due to rising pay rates considered by many contractors to be the only way of maintaining their original net pay position.

As the reforms now affect the private sector, the PAC are concerned that HMRC appear to have done little to try and understand the wider impact of the reforms on workers or labour markets or investigated whether any specific sectors are particularly affected.

Some contractors report that, to avoid perceived risks of failing to comply, their clients are changing hiring practices, such as no longer engaging workers through personal service companies (PSC). This is something that is particularly common in the Construction Industry where large construction companies are advising their agency providers that they will no longer accept PSC or self-employed subcontractors and that any worker provided must be on PAYE.

This approach is both unnecessary where the off-payroll rules or self-employment rules are applied appropriately and is also forcing agencies to engage PAYE workers through an Umbrella arrangement causing the net pay of the workers to reduce significantly, considering the costs associated with employment through an umbrella company.

HMRC appears unconvinced by such evidence and has not, as yet conducted its own research with engagers or contractors into the impact of the reforms, something which the report recommends should be undertaken without further delay.

This apparent lack of information has made it difficult for Government to separate the direct impact of the off-payroll reforms from other recent labour impacting events such as the effects of Brexit and the COVID-19 pandemic so there is no useful data or commentary coming from them to challenge the PAC opinion, perhaps no surprise there.

Perhaps even more concerning is the appearance that HMRC underestimated the additional costs of implementing the reforms to hiring organisations.

Whilst HMRC’s stance is that the reforms are bringing in more tax revenue, the concern remains that some of this yield will arise from the difficulties organisations face when dealing with the rules, resulting in errors and mistakes. It is also clear that structural problems remain with the way the off payroll IR35 rules operate in practice. Hiring organisations cannot always get all the information needed to accurately assess a worker’s status, and it is too difficult for workers to challenge incorrect determinations as there is no independent appeals process.

One of the most perplexing issues is that a lack of solid data and ineffective legislative provisions in cases of non-compliance has also meant that HMRC can end up taxing the same income twice. This is particularly concerning in the public sector where—if workers or their personal service companies reclaim the taxes they already paid—the government could end up subsidising private sector contractors for all of their tax.

To date, whilst HMRC are fully aware of the potential for contractors to reclaim the tax they have paid (on the basis it has also been paid by the engager where a compliance settlement has taken place) they seem unable or unwilling to do anything about it. The more contractors hear about this then undoubtably there will be claims made for repayments, with the ultimate liability being serviced from the general tax paying public.

HMRC needs to 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.

Given the PAC comments it is clear that the consequences of falling foul of the off-payroll rules is potentially very expensive and seemingly very unfair.

Ultimately, it is clearly ironic that one government department is billing another over compliance rules which the state as a whole should have refined prior to unleashing them on the rest of industry!

Perhaps your business should consider taking advice from The Guilds team of IR35 and employment status experts to assist your business in avoiding the potential problems associated with the off-payroll reforms so clearly demonstrated by the PAC report.