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HM Revenue & Customs (HMRC) will review the IR35 off-payroll working legislation in response to the Public Accounts Committee’s (PAC) claims there are “structural problems” that need addressing in terms of how the tax avoidance rules work in the public sector.
Several months have passed since the PAC published its damning report on the fallout from the introduction of the IR35 reforms to the public sector in April 2017, which concluded that HMRC’s “rushed implementation” of the changes caused “widespread non-compliance”.
As evidence of this, the Committee pointed to the list of government departments – which include the Department for Work and Pensions, the Home Office and the Ministry of Justice – that had ended up owing hundreds of millions of pounds in unpaid tax to HMRC for making IR35 compliance errors.
The reforms, introduced by HMRC as part of its ongoing clampdown on disguised employment, were first rolled out to the public sector in April 2017, before being extended to the private sector in April 2021.
Before the changes came into force, limited company contractors were responsible for determining whether or not the work they did for their end-clients meant they should be taxed in the same way as permanent employees (inside IR35) or off-payroll workers (outside IR35).
According to HMRC, this system of self-classification has resulted in some contractors deliberately misclassifying themselves as working outside IR35 in an effort to minimise their employment tax liabilities.
HMRC has now published its response to the PAC findings, which has seen the tax collection agency commit to acting on a series of recommendations the Committee made about how to improve compliance with the reforms. As such, HMRC has agreed to do more research into the impact of the reforms by forging closer ties with contracting stakeholders and government department compliance chiefs, and “consider” what additional customer support it can offer to end-hirers grappling with the changes.
HMRC has also agreed to revise the processes it has in place for contractors who have cause to challenge their IR35 status determinations, and has committed to sharing with the Committee details of a cost-benefit analysis of the reforms. All of these commitments have a confirmed implementation date of December 2023.
However, possibly the biggest piece of work HMRC has agreed to do is respond to the PAC’s recommendation that it review how the IR35 rules are working, and address several problems with how they are known to work in practice.
“Including ensuring that HMRC has the data it needs to accurately reflect each worker’s tax position in cases of non-compliance; and HMRC does not end up taxing the same income twice or unwittingly contributing to workers not paying their fair share of tax,” the PAC recommendation stated.
HMRC came under fire in February 2022 for failing to notify contractors that they could be missing out on the opportunity to reclaim tax they have already paid if the public sector organisation engaging them has fallen foul of the IR35 rules.
This is because, when calculating the amount of tax a non-compliant public sector body owes, HMRC is failing to take into account the corporate tax or value-added tax amounts the contractors working for these organisations will have already paid.
As a result, HMRC has found itself accused of over-collecting tax, which is a claim it has repeatedly denied by stating that it “only collects what is due in law and, as such, HMRC collects the correct amount of tax due under the legislation at the time it is collected”.
In its response to PAC’s recommendations, HMRC said it already has a process in place to notify contractors that they are entitled to seek a repayment of any taxes they have overpaid in instances such as this, and said it will continue to review how this works in practice to ensure it does so as “effectively as possible”.
It added: “Relevant information is needed from the client organisation to enable HMRC to operate the process, as they are the party who engages the worker. HMRC is seeking the required information from client organisations at the outset of a compliance enquiry to increase the chances of obtaining the relevant data. HMRC will continue to review this process to ensure it works as effectively as possible.”
Elsewhere, HMRC also confirmed that it has established a working group with external stakeholders to consider whether a legislative solution can be found so the department can take account of the taxes that have already been paid by contractors.
“[This will ensure] HMRC does not tax the same income twice and that workers pay a share of the tax liability,” it said. “HMRC will continue with this work.”
However, there is no target implementation date shared by HMRC for this recommendation.
Dave Chaplin, CEO of contractor compliance consultancy IR35 Shield, said HMRC’s reliance on the notification procedure where the over-collection of tax issue is concerned is insufficient, and legislation is needed to resolve it. “In my view, this is not strong enough; there should be a statutory requirement for HMRC to locate and process the refund,” he said. “If HMRC fails to do so, the ‘fee-payer’s’ bill should be reduced by a deemed amount of tax paid.
“It is encouraging to read that HMRC is actively seeking to finally resolve the offsets problem, because currently a firm has to unfairly pick up the entire tax bill, and the contractor pays none,” said Chaplin. “Absurdly, in the public sector, if HMRC enforcement overturns ‘outside IR35’ determinations, they end up losing the Treasury money.”