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IR35 news: Audit office criticises HMRC over 'inconsistent' IR35 rollout

Investigation into IR35 has been labelled "damning" by IR35 specialists

IR35 at a glance

IR35 is a piece of legislation designed to tackle tax avoidance from 'disguised employment' where self-employed contractors set up limited companies to pay themselves through dividends, which are not subject to National Insurance.

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It was first introduced in 1999 by then-chancellor Gordon Brown. However, as part of the November 2016 Autumn Statement, current chancellor Phillip Hammond said that public bodies using contractors would be responsible for IR35 enforcement from 6 April 2017.

It's thought that contractors could lose up to 25% of their money with IR35, according to ContractorCalculator, and as a result, almost 85% said they would consider leaving the public sector to work for private companies instead, according to a recent Qdos Contractor's survey.

The IR35 definitions are a little fuzzy, but if you work onsite with your client who also manages you and supplies your equipment, or if you lead a team of employees that work for the client, IR35 will most likely hit you.

This is particularly worrying for government and public bodies, as they rely heavily on IT contractors, and many of those resources would be put at risk with the IR35 rules.

Head to our What is IR35? page for a detailed breakdown of the legislation.

Latest news: Audit office criticises HMRC over 'inconsistent' IR35 rollout

HM Revenue and Customs (HMRC) is facing criticism after a scathing National Audit Office (NAO) report revealed significant inconsistencies in the implementation of IR35 tax reforms.

First rolled out in April 2000, IR35 aims to curb the longstanding issue of contractors establishing limited companies to avoid contributing to income tax and national insurance. In 2017, the legislation was introduced to the public sector with “little time” to prepare, according to NAO. In 2021, IR35 was extended to the private sector.

The NAO’s newly-published findings revealed significant difficulties in using the ‘Check Employment Status for Tax’ (CEST) online tool, as well as inadequate notice given to the public sector ahead of the IR35 implementation. It also found that it is overly difficult for contractors to make an appeal in their case once a status has been assigned.

The report follows a 2021 survey, also conducted by the NAO, which found that more than a quarter (26%) of central government respondents admitted to workers “frequently or occasionally” challenging employment status determination, with no “clear legal route to appeal further”.

“If workers believe they have been taxed incorrectly, their recourse is to use HMRC’s self-assessment and NIC reclaim routes. This is the same as for any worker considered an employee, but differs from the previous system whereby the worker’s PSC made the determination and so the worker would have no reason to dispute it,” the NAO report stated.

Meanwhile, the 2019 update to the CEST tool had caused a rise in ‘unable to determine’ outcomes, with one in five (20%) of cases being labelled as such.

Seb Maley, CEO of IR35 consultancy and contractor insurance provider Qdos, described the findings of the NAO investigation as “damning”, adding that it “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,” he said.

The report said the current approach to correcting cases of non-compliance assumes the contractor has fully used their tax-free personal allowance on income earned elsewhere. The result is that, in many cases, more tax is collected than is actually due, and that HMRC has yet to provide a clear plan on how to address this.

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It also found that HMRC may have underestimated the additional administrative burden that would be placed on the private sector once IR35 was expanded in 2021. Specifically, it failed to take into account additional costs, such as the need for investment into dedicated staff and formal approval structures – something the public sector had experienced in the initial rollout.

Commenting on the investigation’s findings, Dave Chaplin, CEO of compliance firm IR35 Shield said that the report “serves to shine another bright spotlight on the flaws seeping through CEST”.

“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, evidenced by the number of Government departments that got Off-payroll wrong,” he added.

Chaplin also addressed HMRC estimates that the 2021 extension of IR35 into the private sector affected almost four times the number of people with significant control (PSCs) affected by the 2017 reforms, creating “a bigger challenge” in monitoring risks of non-compliance. Last year’s government departments and agencies’ financial statements included a total of £263 million paid, owed, or expected to be owed to HMRC for failing to administer the reforms correctly.

“With the NAO stating that the private sector is four times bigger, does this mean there is a £1bn tax bomb ticking away that when detonated will send businesses to the wall, despite them all acting in good faith and trying to adhere to the new rules?” asked Chaplin.

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