According to a report by MPs, government departments are guilty of high levels of non-compliance with the UK non-payroll tax system.
Difficulties in complying with IR35 rules, which apply to many IT contractors, across central government reflect poor implementation by Her Majesty’s Revenue and Customs (HMRC) and other government agencies, said the Public Accounts Committee (PAC).
“Central Government is spending hundreds of millions of pounds to cover tax due for people wrongly assessed as self-employed. Government departments and agencies were due or expected to owe HMRC £263m in 2020-21 due of poor administration of the rules,” the report said.
What is IR35?
The IR35 is a reform unveiled in 1999 by the British tax authorities. The latest regulatory change – which came into force in April 2021 – requires medium and large businesses in the UK to define the tax status of their contractors and freelancers. Previously, this was set by the contractors themselves.
Entrepreneurs who are within the scope of the legislation – that is, inside the IR35 – will have to pay more tax than they think.
The reforms are part of the government’s crackdown on so-called disguised employment, where workers behave like employees but avoid paying regular income tax and national income contributions by charging for their services through CSPs, which are taxed at lower rates for businesses.
The measures first came into effect in the UK public sector in 2017. The UK government hoped the reforms would claw back £440m by bringing together 20,000 contractors.
HMRC estimates that only one in 10 private sector contractors who should be paying tax under current rules are doing so correctly. He estimates the reforms will recoup £1.2bn a year by 2023.
“This is not acceptable as government departments should be well placed to understand the rules and communicate with HMRC. However, mistakes were likely as reforms were rushed by HMRC and public bodies had little time to prepare – in particular, they only had two months or less with HMRC’s new guidance and tools before the new rules came into force.”
New IR35 rules were introduced for businesses in April 2022 after a year-long delay caused by the COVID-19 pandemic. The rules were introduced in the public sector in 2017.
Part of the compliance problem was due to advice from HMRC and the Check Employment Status for Tax (CEST) tool. “Some questions within the CEST were difficult to interpret correctly, and the advice was long, too general in scope and not integrated into the CEST itself,” the CCP said.
Such difficulties do not bode well for IR35 in the broader trading environment.
“Despite years of reform of the IR35 rules, there are still structural problems in how they work in practice. The IR35 rules do not work well with the realities of contracting, both in determining the tax status of workers and in resolving problems when mistakes were made,” the report said.
In February, HMRC’s chief compliance officer, Nicole Newbury, told a PAC hearing that companies implementing blanket bans on contracting personal services companies may be found not to have complied with tax reforms for freelancers, but that challenging the decisions could be a long process.
Seb Maley, CEO of tax adviser and insurer Qdos, said the PAC’s IR35 review was “damning” and highlighted many government failures.
“As well as highlighting the staggering levels of non-compliance in the public sector following the reform, it exposes the flaws of the CEST, which frankly is still not fit for purpose despite being launched there. five years old,” he said.
“He also calls on the government to do more when it comes to assessing the real impact of the IR35 reform on the labor market. HMRC said the changes generate more tax revenue, but this is not not necessarily a sign of improved compliance. In our experience, this is a direct result of real contractors being forced to work on the payroll.” ®