Defra pays HMRC a ‘staggering’ IR35 bill of £86.5million for off-payroll mistakes

Defra has had to pay HMRC an additional £23.3million for getting IR35 wrong, taking its total liability for off-payroll errors to a swingeing £86.5million.

The Department for Environment, Food and Rural Affairs cautioned back in November 2021 that work to determine its “final liability” for fluffing IR35 status tests was still “continuing.”

'£86.5m settlement'

At the time, Defra had already paid £19million to HMRC, thereby accepting Defra officials had erred in CEST-testing limited company contractors under the 2017 off-payroll rules.

Then, Defra estimated its remaining IR35 liability to the taxman would likely come in at £48million – an amount that was exclusive of any interest HMRC would charge.

But like the MoJ, where putting too many PSCs outside IR35 when HMRC believed they were inside IR35 inflated its liability (six-fold), Defra has quietly admitted its total HMRC settlement for off-payroll errors has ended up rocketing -- from a recalculated £63.2m (as of October 2022) to a final settlement of £86.5million.

'Humiliated, mortifying'

A Defra spokesperson confirmed the £86.5million liability for IR35 non-compliance by the department yesterday to ContractorUK.

Including an extra £4m in HMRC interest, Defra’s grand total for bodging IR35 should have made the spokesperson feel “humiliated” or at best “uncomfortable,” a status expert says.

“But it’s even more mortifying for HMRC and HMT, assuming they realise what this staggering bill for Defra misapplying IR35 reforms means,” said the expert, Kate Cottrell.

'Wholly inadequate HMRC assistance'

Status advisory Bauer & Cottrell’s co-founder, she explained: “It means the guidance they provided to the public sector at the time was clearly not worth the paper it was printed on.

“It also means assistance given by HMRC to taxpayer-funded bodies like Defra was wholly inadequate. And it means CEST is a complete failure. It wasn’t, and isn’t fit for purpose.”

Work done by HMRC and HMT to prepare the public sector for the 2017 rules clearly left engagers with the impression that IR35 was a “box-ticking exercise,” believes a tax lawyer.

'Box-ticking exercise'

“And that box-ticking exercise includes the use of CEST,” the lawyer, Rebecca Seeley Harris, who has written a book on CEST told ContractorUK.

Founder of ReLegal Consulting, she added: “There’s no point in pretending that substitution is a viable option, for example, because it will get you an ‘outside’ determination…when the reality or the contract does not back that up. 

“This, I believe, is what happened at Defra. The hiring manager said that there could be substitution, when in fact there were no provisions for it in the contract.”

'Even a private sector IR35 tool wouldn't have helped'

However the ‘divisive CEST substitution question’ as she has described it previously, isn’t just the public sector’s problem.

“It seems this [question is to blame] in the Defra case….[but it pops up in] other cases that I have dealt with in the private sector,” explained Seeley Harris, author of CEST Explained.

“While CEST undoubtedly needs some work on it, the result of Defra’s ‘re-assessment’ could have happened even if the hiring manager had used a private [sector-built] tool.” 

'Six per cent outside IR35'

Reassessments at Defra were disclosed in November 2021, when an outside IR35 determination for 85% of PSCs shrank, upon HMRC intervening and Defra reassessing, to 22% of PSCs.

That one-fifth or so then got spliced even further, with ‘outside IR35’ eventually allocated to just six per cent of the contractor workforce at Defra.

A former tax officer is alive to the disconnect between what HMRC likes to quote about IR35 non-compliance, and what appears to have happened ‘on the ground’ in the public sector, at an actual site.

'Far short of HMRC's 90% non-compliance claim'

“After receiving advice and guidance from HMRC in a 2019 investigation, [Defra’s] approach to its status handling was amended and since then almost 30% of contractors were ‘inside IR35.’ 

“This means HMRC pointed out -- and had their recommendation accepted -- that about 25% of contractors who should have been operating IR35 were not.

“Well, this is far short of the 90% of contractors who HMRC has claimed for years and years were breaching the IR35 rules,” said the ex-tax officer, Carolyn Walsh.

She continued to ContractorUK: “That should not be overlooked because that ‘90% flouting the law’ claim was a bit of a catalyst for the IR35 legislation being reformed.”

'Just HMRC's opinion, and no easy ride for HMRC'

The Revenue’s far from universally accepted claim that nine out of 10 PSCs breach the Intermediaries legislation isn’t sector-specific.

But there is one big difference between public and private, and it’s a difference that the taxman isn’t going to like, assesses Cottrell.

“The most shocking aspect…is that the public sector blindly accepts HMRC’s opinion -- and it is just that – an opinion. The opinion is Defra have got [IR35 status] wrong, and they are unable to go to the tax tribunal or courts.

“But there will not be such an easy ride for HMRC in the private sector,” she says. “Many in the private sector have sought specialist IR35 advice and gathered all the evidence needed to defend any challenge by HMRC.” 

A former inspector for the Revenue, Cottrell also told ContractorUK: “It is of course only the public sector that can just accept owing millions of pounds. The majority of private sector businesses would have to fight -- and they will fight, as the potential sums involved would put them out of business and many thousands of their employees out of work”.

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Written by Simon Moore

Simon writes impartial news and engaging features for the contractor industry, covering, IR35, the loan charge and general tax and legislation.
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