IR35: NAO off-payroll report 'shows extending rules to small companies would be madness'

The government would be “mad” to extend April 2021’s IR35 off-payroll rules to small companies if a new report by the National Audit Office (NAO) is anything to go by.

This is according to one of HM Treasury’s own former secondees on IR35 policy Kate Cottrell, who says the report exposes HMRC as facing ‘serious problems of its own making.’

“The NAO’s evidence is of a rushed legislation based on wholly inaccurate HMRC estimates; wholly inaccurate cost predictions to public bodies and a wholly ineffectual CEST.”

“And the most concerning of all for contractors,” Cottrell, who is ex-Revenue continued to ContractorUK, “is that what HMRC actually charges is wrong. It collects more than is due."

“[So the] government would be quite mad to extend the new rules to small businesses. Well, at least not for 10 years to see how the reform affects medium and large businesses.”

'Many gaping holes'

This fantastical grace period of a decade actually seems proportionate, however, given the ‘many gaping holes in HMRC’s IR35 reform plan’, as Qdos puts it, in the NAO‘s 60 pages.

And such a ridiculously long timeframe like 10 years is the extreme opposite of what public sector organisations and their contractors were afforded by HM Treasury and HMRC.

“Public bodies had little time with the new guidance and tools before the rules came into effect,” began the National Audit Office, scoldingly.

“HMRC published its guidance in February 2017, two months before the rules came into effect.

“Furthermore, it made available the full version of CEST – a key tool to help public bodies determine the tax status of off-payroll workers – in March 2017, with only one month to go.”

'HMRC rightly criticised by the National Audit Office'

As well as Ms Cottrell of status advisory Bauer & Cottrell, three other IR35 experts told ContractorUK, independently of each other, that the reform’s rushed start was a fatal error.

It was not something HMRC or affected organisations could ever take back, or recover from, and it led to numerous other mistakes.

Danny Batey, senior consultant at Markel Tax explained to ContractorUK: “The last-minute nature and [rapid] speed of rollout of the 2017 rules has been rightly criticised by the NAO.

“[In our experience this combination] left most public sector organisations ill-prepared, with their prior concerns [about the new IR35 framework] evidently ignored by HMRC.”

'HMRC made a big mistake'

Carolyn Walsh, a former tax official said in a statement last night to ContractorUK: “HMRC made a big mistake in enforcing the IR35 reform in the public sector with such little notice.

“[It] served to highlight a lack of expertise and resources available to public sector bodies; the absurdly high volume of contractors who were in fact agency workers being engaged in the public sector [given the NAO counts 50,000 PSCs shut and joined payrolls in the reform’s first two years].”

Now boss at CWC Solutions, Ms Walsh added: “And it highlighted that the CEST tool was flawed. But it wasn’t just clients, agencies and workers caught short. HMRC weren’t ready in 2017 either, that much is now clear.”

'Yes, I think HMRC is being blamed here'

Significantly, this rushing of the rules in 2017-- NAO says for example that HMRC’s “technical guidance on employment status was long, detailed and not integrated into CEST,” is still hurting today, some five years later in 2022.

“Yes, I think the National Audit Office is [blaming HMRC for the likes of MoJ, Defra and other ministerial departments which have just paid a total of £263million in HMRC penalties for getting IR35 wrong],” says Qdos’ Seb Maley.

Responding to queries from ContractorUK, the IR35 contract review firm’s CEO, Mr Maley explained: “The NAO makes clear that public sector bodies weren’t given enough time to prepare.

“And the watchdog points out that CEST was rolled out just one month prior to the changes. These are two challenges created by HMRC which ultimately led to non-compliance.”

'Highly likely that mistakes would be made'

The National Audit Office put this ‘problems of its own making’ characterisation in its own words on page 12 of its report.

“Public bodies had little time to prepare; some found it difficult to use the original guidance and tool that HMRC had provided; and there was a limited understanding on all sides of how much time and resource were needed to get it right.

“As a result,” the National Audit Office concludes, in what might be its most damning finding against HMRC, “it was highly likely that some public bodies would make mistakes.”

Asked about the NAO implying HMRC may be to blame for the millions in fines being paid by other departments for fluffing IR35, a spokesperson for HMRC declined to be drawn.

'Uncertainty over HMRC's approach'

The closest the HMRC spokesperson came to addressing the issue was to say: “We have continued to adapt our approach to improve compliance with the rules in the public sector, support organisations to get things right, and enable a successful extension of the rules to the private and voluntary sectors.”

But the NAO report doesn’t say that. The watchdog says that while HMRC “appears” to have learnt lessons, “there is uncertainty over HMRC’s approach” to the private sector on IR35.

This unflattering, bleak assessment by the watchdog seems partly rooted in the public sector, where the report strongly implies organisations were not given a full deck to play with.

'Reasonable care'

The NAO says: “The financial liabilities [totalling £265million] resulted from HMRC’s assessment that those departments and agencies were getting status determinations wrong.

“In all cases of non-compliance, HMRC found that the public body had not taken 'reasonable care' to prevent errors, including when answering questions in CEST. However, it [HMRC] had not set out how it would interpret reasonable care for the new requirements when they first took effect”.

Last month, client-side IR35 adviser Rebecca Seeley Harris shared with ContractorUK that a CEST substitution question was often why hiring managers come unstuck under HMRC scrutiny.

Indirectly confirming that the adviser was correct, NAO says: “HMRC has so far found that the most common errors public bodies made were wrongly considering that they would always accept a substitute when they had a right to reject one”.

'Exactly the same problems in the private sector today'

Ms Cottrell, who was seconded by HMT to help improve IR35 in 2010 reflects in an article today exclusively for ContractorUK: “Every issue mentioned in the NAO’s report reflects exactly the same problems that the private sector is experiencing -- right now .

“That’s together with the very real fear that they [clients] may have [got IR35 and assessing contractors’ IR35 status], wrong.”

Yet the National Audit Office found the Revenue has been getting IR35 wrong too, and from the same specific standpoint of accurate tax collection, it still is.

'Collecting more tax from contractors than is due'

“HMRC’s current approach to correcting cases of non-compliance results in it collecting more tax in total than is due,” the NAO says, in one of its most damning findings against HMRC, but one which ContractorUK understands the Revenue is now looking to address.

The NAO continued: “[HMRC] does not yet have a plan to address this. [Currently, the department] does not offset the total amount against any tax the worker or their PSC already paid and [HMRC] told us this was not allowed within the current legislation. This means that HMRC collects more tax in total than is due.”

Having read just last week that the 2017 off-payroll rules are working well, albeit in a study commissioned by HMRC, Markel’s Mr Batey can’t quite believe what the NAO has uncovered.

“These findings are poles apart from the conclusions drawn by HMRC’s independently commissioned report…which gave the impression that everything in the IR35 off-payroll garden was rosy,” he says.

'HMRC ignores your corporation and income tax payments'

At Qdos, Mr Maley is also almost lost for words. “[Yes you’ve read that right --] HMRC nets more tax overall than is actually due [in cases of IR35 non-compliance].”

He explained: “If HMRC finds a contractor has been wrongly engaged outside IR35, the tax office ignores the fact that the contractor will have already paid corporation tax and income tax on these earnings. HMRC won’t offset the amount”.

Making awkward reading for the Revenue, the department’s officials acknowledge that they are sitting on a net increase in tax revenue -- due to the revised IR35 off-payroll rules -- of £250million. That represents a £100million increase on what even HMRC itself expected.

'Revenue not actively promoting the claim back method'

Further awkwardly for the taxman, and potentially explaining why he has smashed his own £150milion IR35 yield, the NAO also report that he has kept quiet about how the IR35-wronged can be refunded.

“Once the non-compliant client organisation accepts that its determinations were incorrect, the workers become entitled to claim back the tax,” the National Audit Office said, adding: “However, HMRC does not actively promote this.”

Sounding almost disgusted, Qdos’ Mr Maley said that if HMRC didn’t have a legal obligation to not overtax its customers, it certainly has a “moral obligation”.

'National injustice, potential rerun of the Loan Charge'

He told ContractorUK: “I can’t currently comment on the legalities but without doubt, this report by the NAO has highlighted the injustice of this issue on a national scale.”

Ominously, CWC’s Ms Walsh, an accountant, is also worried about history repeating itself in the worst possible way.

“I agree with the National Audit Office that HMRC is making a mistake in not clearly laying out the recovery procedure.

“There are instances of companies using contrived Status Determination Statements backed up by insurance policies that won’t actually pay out, leading contractors in to a risky situation as they are not challenging an incorrect determination, and then carrying on not paying the right amount of taxes, because they believe the employer will cop the bill, or the insurance policy will cover their debt. 

“It really isn’t becoming of a government department to hand out lengths of rope with which taxpayers can hang themselves. So HMRC needs to shape up very quickly here, or there will be another Loan Charge-type disaster looming for contractors,” Ms Walsh said.

'More effective and efficient'

As well as declining to comment on being blamed for the IR35 penalties which the public sector is paying, HMRC offered no word, officially, on the NAO’s recommendation ‘e.’

In particular, ‘e’ is one of the NAO’s six multi-faceted recommendations to HMRC on IR35, and is additional to six recommendations made in the report by public bodies directly.

Recommendation ‘e’ states: “Develop a more effective and efficient system to ensure HMRC accurately collects the total taxes due from workers and hiring organisations when errors have been made”.

'Eye-watering'

If Markel Tax was deciding, one recommendation to HMRC would be to improve its education resources -- those it offered to the public sector, but also those today being offered to the private sector ahead of the ‘soft-landing’ ending.

The firm’s Mr Batey said: “The…eye-watering PAYE and NIC liabilities totalling in the region of £260m surely question the value of the training and guidance received from HMRC – both in terms of IR35, and the use of CEST.”

Sounding sympathetic to his concerns, the National Audit Office says “questions remain” about the systems for how contractors will be able to dispute incorrect IR35 determinations.

And the report says HMRC faces new risks that will make it “harder to identify, monitor and address non-compliance,” including in the private sector’s larger and more complex labour markets.

'Baffling'

Nevertheless, the NAO points out that the Revenue has observed an increase in tax revenues and numbers of workers deemed to be employed for tax purposes.

Quite how a framework can be deemed successful when money from taxpayer-facing departments for flouting it has been lost to HMT in fines is “baffling” to Markel’s Mr Batey.

But HMRC took the NAO’s indirect compliment.

“We welcome the [National Audit Office] report’s recognition that the reforms succeeded in making the tax system fairer, with increased compliance with the off-payroll working rules,” said the HMRC spokesperson, adding: “More people working like employees have paid tax like employees, levelling the playing field.”

'More accurate reflection of public sector IR35 experience'

Describing her team as “flat out” with IR35 status review requests and enquiries, is an unconvinced Ms Cottrell.

“HMRC is facing very serious problems in ensuring compliance,” she said. “Many of these problems are of their own making, brought on by HMRC’s failure to believe the views of stakeholders before the April 2017 implementation, choosing instead – wrongly -- to dismiss all the evidence as ‘hearsay’ – but it’s that same evidence which they now see before them in the National Audit Office’s welcome report.”

Both Qdos and Markel backed the NAO’s off-payroll report too, hailing it as a “much more accurate reflection” than the HMRC-commissioned research of the “negative experience” of most public sector organisations since IR35 reform was introduced in April 2017.