Committee of Public Accounts highlights high levels of non-compliance with IR35 in central government

Recently, the House of Commons Committee of Public Accounts – a cross-party committee of MPs appointed by the House of Commons to examine “the accounts showing the appropriation of the sums granted by Parliament to meet the public expenditure, and of such other accounts laid before Parliament as the committee may think fit” – quietly published a report entitled “Lessons from implementing IR35 reforms”.

The report, which can be downloaded here, is a damning account of the IR35 reforms in the public sector (implemented April 2017), raising concerning questions about how much HMRC has done to understand the wider impact of the legislation, what the reforms are actually achieving, and what is being done to support end clients, recruiters and contractors. What’s more, the learnings corroborate the findings of Kingsbridge’s own IR35: One Year On survey, which were published in a whitepaper earlier this year. The report is extremely significant as, unlike previous government reports on IR35, this finds no redeeming features of the legislation or how it has been implemented.

In response to the report, Ryan Dawson, IR35 Program Manager at Kingsbridge commented: “HMRC are committed to making the tax system fairer, but you are left wondering just how fair IR35 reform is for supply chains when according to PAC, HMRC is not doing enough to understand the impact of the reforms on workers and labour markets. HMRC’s guidance, information and CEST tool have all been damningly criticised and when you see £263m in back tax owed by government departments due to non-compliance who all equally were led by HMRC, you again find it difficult to trust HMRC or the CEST tool. This highlights the importance of independent IR35 experts who can legitimately support organisations. Anybody using CEST, I would urge you to reconsider your position and partner with a business that can hold the hand of your supply chain.”

Here, we summarise the findings of the Committee’s report and how they intersect with our own findings. While the report refers specifically to the public sector reforms, many of the learnings can also be applied to the private sector reforms, implemented more recently in April 2021.

“High levels of non-compliance in central government reflect poor implementation by HMRC and other government bodies.”

The report uncovered that “government departments and agencies owed, or expected to owe, HMRC £263 million in 2020–21 due to incorrect administration of the rules”. This is, of course, unacceptable. Government departments should be best placed of anyone to understand the rules and communicate with HMRC and it lays doubt as to how well non-government bodies can be expected to understand the changes. The Committee blames the fact that HMRC “rushed” the reforms and gave the public sector little preparation time, as well as the well-documented issues with the Check Employment Status for Tax (CEST) tool.

Their recommendation is that “HMRC should develop robust estimates of non-compliance for the public sector as a whole and use this to identify areas where it can reduce the inherent challenge of complying with the reforms,” which suggests that these estimates were not already in place, implying a lack of key data by which to measure the success – or lack thereof – of the reforms. HMRC “should adopt a similar approach for the private sector as the reforms bed in and write to [the Committee] with an update in six months’ time.”

“We are concerned that it is too difficult for workers to challenge incorrect status determinations.”

This is something that Kingsbridge have been talking about for some time and is an issue that has been raised to us by contractors on many occasions. One of the findings in our whitepaper is that, “Of those contractors who have had an inside IR35 determination in the last 12 months, 90% did not find the appeal process easy, and/or believe they did not have a fair hearing.” This is a shockingly high number and it tallies with what the Committee has found:

Workers can challenge decisions with the hiring organisation, but they have no independent route to appeal. The hirer must respond formally to an appeal from a contractor within 45 days. However, if they do not change the status, the worker has no further recourse other than to seek a refund from HMRC by completing their self-assessment return on a self-employed basis.

Seeking a refund from HMRC, however, is something of a nuclear option as it may trigger an investigation. It is disappointing that there is no middle-ground route available to contractors, which the Committee appears to agree with, recommending that HMRC implements a fast and independent appeals process and assess how well the existing appeals route is working. With our finding that 90% of those who use it did not find it easy, or that it allowed for a fair hearing, we agree that this needs to be assessed as soon as possible.

“HMRC is not doing enough to understand the impact of the reforms on workers and labour markets.”

The Committee points to the complexity of IR35 rules and the perceived increased risk to end clients as potentially leading to behaviour changes by both hirers and contractors. “In some cases,” they write, “contractors have reported that their last clients had stopped all use of PSCs, while some contractors have increased their rates or avoided work if it is within scope of the IR35 rules.” There is a definite suggestion that some organisations are moving towards a state of overcompliance, with blanket bans on PSCs or blanket determinations of inside IR35 to minimise risk. They point out that HMRC has not carried out research into these wider impacts and that HMRC has been dismissive of people and businesses that have been negatively affected.

This is strongly supported by our own findings:

• End client and recruitment businesses have seen a drop in contractors since the IR35 reform (approx. 70-80% of respondents agreed with this point). The reform has clearly had a dramatic and inhibiting effect on the willingness to hire contract labour
• 50% of end clients reported that IR35 was the biggest obstacle to hiring contractors in the past 12 months
• 66% of contractors have said they would not consider an inside IR35 role
• Some contractors have considered closing their businesses (49%), retiring or leaving the UK entirely – with a quarter seeking work abroad due to IR35 reform.

This shows that the impact hits at both sides with end clients finding their talent pool shrinking and becoming more expensive, while contractors find the number of roles they would be willing to consider going down. We support the Committee’s recommendation that HMRC conduct an impact study into the IR35 legislation “to check it is being applied as intended and not adversely affecting employment opportunities.”

“We are not confident that HMRC works proactively to establish whether any sectors have been affected disproportionately by the reforms and why.”

We have all read about UK supply chain issues in recent months, largely caused by Brexit and the war in Ukraine. It wouldn’t do, however, to dismiss IR35’s role in this.

The Committee says it’s “unclear” how the IR35 changes factor in but some organisations have previously pointed to IR35 as a contributor (the Road Haulage Association, for instance). The Committee does say though that they  “do not have confidence that HMRC is identifying which sectors may be disproportionately affected, nor that it is working proactively with affected sectors to understand what issues they are facing and how these might be addressed,” which again points to a worrying lack of data. They recommend that:

HMRC should 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. HMRC should write to us with an update in six months with the outcome of this public engagement.

“HMRC has not made a robust assessment of the additional costs of implementing the reforms.”

The Committee has further issues with HMRC’s research and data when they point out that although HMRC say that the IR35 reforms have increased tax revenues by increasing the number of people employed for tax purposes, it is unclear how much of this is down to other factors such as Brexit, the pandemic and other changes in the public sector to reduce the use of contractors. They go on to add:

There is also not a complete picture of the costs of the reforms against which the benefits could be compared. The government introduced the reforms because it considered it too costly for HMRC to oversee an effective compliance regime with each individual PSC. HMRC also concluded that hiring organisations could administer the rules for less cost than PSCs doing it themselves. However, HMRC’s modelling of the cost to hiring organisations works out at just £35 a year per PSC, based on a theoretical minimum needed to comply. HMRC does not know what it actually costs all parts of the labour supply chain to administer the reforms in practice.

As we have seen from our whitepaper, 37% of contractors deemed inside IR35 have seen their day-rate increased compared to 20% of contractors deemed outside IR35, so engagers are almost twice as likely to have to pay a contractor more to work inside IR35. In addition to this, 65% of contractors said they have or would try to negotiate an increased rate if placed inside IR35. This is going to amount to a lot more than £35 per year per PSC, plus the costs of using independent status assessment tools and other associated costs. HMRC’s modelling seems to vastly underestimate the costs of implementing the reforms by ignoring the various impacts. This is reflected in the Committee’s recommendation on this point which sees them ask HMRC to present a cost-benefit analysis to Parliament “that reflects the actual costs of compliance to HMRC itself, hiring organisations, workers and others in the supply chain.”

“Despite years of reforming the IR35 rules, there are still structural problems with how they work in practice.”

Perhaps one of the most damning statements in the report is: “The IR35 rules do not work well with the realities of contracting, both in determining workers’ tax status and in resolving issues when mistakes have been made.” It flags several issues that demonstrate this:

• Recruiters generally don’t share the details of contractors with end clients until they are being hired, which means that a) end clients can’t begin the process of status determination until the contractor has been hired, and b) the contractor cannot know if they will be found inside or outside IR35 until they have already started working.
• There is an issue with double taxation since “the legislative framework does not allow HMRC to offset liabilities against taxes already paid, meaning it collects tax twice on the same income and workers become able to reclaim all the tax they paid” without needing to compensate their end client. In terms of the public sector, this is particularly uncomfortable as it means government bodies take on the cost and responsibility of paying all tax on contractors who have been incorrectly assessed as self-employed, while the contractor pays nothing.

The Committee recommends that HMRC review how their system is working, how it can be improved, particularly ensuring that it has the data it needs to reflect each contractor’s tax position in cases of non-compliance, and that it does not end up taxing the same income twice.

Whether HMRC chooses to take the Committee of Public Accounts up on any of their recommendations remains to be seen but this report adds to the growing evidence that the IR35 reforms not only don’t work in the way they were intended, but actually add to the problems they aim to solve.