MPs probe public sector’s £263 million of IR35 errors
The House of Commons Public Accounts Committee (PAC) met with HMRC on Monday 21 February to talk about off-payroll working rules (IR35), after the National Audit Office (NAO) published a report on this earlier this month. The NAO report found that public sector bodies have paid or owe a total of £263 million because they have not administered reforms correctly. HMRC told the MPs that this was despite ‘really intensive’ help from them.
(Our NAO report write up is here.)
Also, during the session HMRC said they had not found evidence employers were putting ‘blanket bans’ on hiring contractors using personal service companies, and also ruled out extension of recent reforms to small businesses.
Witnesses at the session were Jim Harra, Chief Executive, HMRC, Nicole Newbury, Director for Wealthy and Mid-Sized Business Compliance, HMRC and Pete Downing, Deputy Director Employment Status and Intermediaries, HMRC.
Conservative Sir Geoffrey Clifton-Brown (photographed below thanks to Parliament UK) asked for an update on border issues affecting HMRC. Jim Harra said compliance, such as the switch to import declarations and hauliers using the goods vehicle movement system, have gone well. There are very low levels of turn-backs by the ferry operators of lorries that do not have the right paperwork, and freight is moving and flowing across the border both ways, he said. No delays are related to the performance of customs IT systems CHIEF or CDS.
But Labour’s Nick Smith cited Rod McKenzie of the Road Haulage Association as reporting regular four-hour delays at Dover. HMRC’s Harra said the ‘traffic control project’ was put in place several times during January but that the delays were down, ultimately, to a reduction in ferry capacity due to refitting last month.
Government departments and IR35 reforms
Labour’s Dame Meg Hillier, Chair of the PAC, (photographed above thanks to Parliament UK) found one of the ‘staggering stand-outs’ of NAO Report that the 2020-21 financial statements of government departments show that the public sector and its agencies has paid or owes a total of £263 million because it has not administered these reforms correctly. HMRC’s Nicole Newbury said that central government departments seemed to struggle with the rules more than other public sector organisations. Some of this is down to key personnel in those departments not understanding the contractual framework that they were operating in, she suggested.
Newbury said this had happened despite HMRC working ‘really intensively’ with the public sector during 2016 and 2017 to ensure that they were ready to implement the reforms effectively. Lessons were learned from the 2017 rollout of the off-payroll to public sector, for the 2021 rollout to private sector, she insisted. These included HMRC doing 100,000 write-arounds or digital touch points with affected customers, running multiple webinars with stakeholders and providing comprehensive guidance and the Check Employment Status for Tax (CEST) tool. Nevertheless, she said, it is ‘really early days’ to know whether similar errors have been made in the private as in the public sector.
Hillier remarked that the public sector - the taxpayer - is paying £263 million to HMRC, which goes to the Exchequer one way or another, but nevertheless it ‘goes around the loop’. Then, you have private contractors that can claim that tax back, ‘so basically they are having their tax paid by the taxpayer’. Harra said the way it should work is that employers get determinations right and the deduction flows from contractors. It is only where they do not get it right that we end up in this situation where they have to rely on their ability through their contracts to go back and get reimbursement from the contractors. “We have no knowledge about the extent to which they are or are not doing that.” Harra accepted Hillier’s point that there is a big risk that the taxpayer could be funding the tax of private contractors.
The NAO report sets out that HMRC have undertaken 59 full compliance checks or more detailed compliance checks across the public sector, and HMRC have been able to close a higher proportion as being compliant in other sectors than in government departments. This is down to misunderstandings of the rules in the public sector, said Newbury.
IR35 and those working in media
Lib Dem Sarah Olney asked what HMRC are doing with the broadcasting sector to clarify the rules around how their tax affairs should be administered. HMRC’s Harra said most of the high-profile media cases are historical and they do not necessarily relate to the hiring and contractual practices that broadcasters have in place today. HMRC have worked with the industry to develop guidance but there will always be ‘edge cases’ where people have a right to dispute it. Why is there not an appeal process that everybody can use? asked Olney. Harra said there is now a statutory dispute process that workers have got the right to raise. Ultimately, If the engager says, ‘No, you are employed’, and they continue to disagree, they do have the right to ‘self assess’ to HMRC what they believe to be the correct tax treatment. Then it is up to HMRC to determine whether they accept that.
HMRC’s Pete Downing commented on the Atholl House case (relating to BBC presenter Kaye Adams), which is at the Court of Appeal. He explained that this largely concerned the ‘in business on own account test’. The employment status test is multifactorial, so there are a number of tests that you need to go through. Then, at the end, it is broadly a question of whether the overall arrangement supports a conclusion that this is a contract of employment (which took up most time at Court of Appeal). Downing said there will be some wider implications if HMRC lose that case, especially on those who are portfolio earners. He said: “Those are the cases where we would have to reassess and consider, first, whether our guidance and various guidance products are correct, but also consider our approach in current compliance action and litigation around those.”
IR35 and IT workers
Sarah Olney said IT contractors in her constituency say they are missing out on contracts because engagers in the private sector do not want to have to go through the process of assessing them for IR35 and are actually engaging abroad, where the rules do not apply. Jim Harra said HMRC research on this has not concluded as yet.
Harra told Olney that while there is a new burden on the engagers of having to comply with the rules, the burden is removed from the personal service companies (PSCs) and their workers, and overall, that gives a small marginal net reduction in the compliance costs year on year.
Public sector reforms preparation
Jim Harra said it was fine to give public bodies two months to prepare for the policy change because HMRC were having one-on-one conversations with large bodies and issuing a lot of communications and guidance for people before that, and public sector bodies should have been familiar with the concepts because they make employment status decisions all the time. He was unconvinced that a trial year, as suggested by Sarah Olney, would have been worthwhile because there was money being lost and these bodies should have been able to step up and meet these obligations in the time available.
His colleague Nicole Newbury said the 2021 rollout was better than the 2017 public sector one because HMRC have brought all the stakeholders together, adopted a multi-channel approach to communication, updated their guidance on the CEST and further guidance that takes account of recent case law developments and responses to feedback.
Harra claimed the 2017 reforms and, HMRC’s early data suggests, the 2021 reforms, have achieved their objective of improving compliance with the off-payroll working rules, which was dogged for over 20 years by very high levels of non-compliance. He said: “we are now seeing what was a theoretical fairness become an actual fairness.”
Yield from the reforms
Jim Harra said higher-than-expected yields from public sector reforms demonstrate that the measure is having an impact: “in the first year of the public sector reforms, the net increase in yield was about £250 million — higher than we had forecast. In the second year, it was higher again, at £275 million.”
Pete Downing said that HMRC are tracking the PSCs that HMRC expected to come into the scope of the reform to see if they start paying employment taxes where they had not done before. As HMRC track them, they find that the individuals working through those PSCs are paying more tax than they were pre-2021, but it will be some time before HMRC can give an out-turn figure on that.
Behavioural changes and blanket bans
How much do you care about whether people are being miscategorised? asked Hillier. Harra said there is still quite a bit of contracting with PSCs, so HMRC have not seen that kind of blanket ban that was talked about. There is definitely behaviour where there are more people coming on to direct engagement on the payroll or going into umbrella companies, he said, and the reforms may well have indirectly caused that change, but that is not something HMRC are overly concerned about provided the ability to have a flexible labour market continues.
CEST has been used about 1.26 million times, which is an indication that engagers are using it case by case, Harra said, and ‘you would not necessarily see that volume of usage if there were lots of blanket determinations being done.’
On media cases, HMRC are making progress, said Harra, adding HMRC have had about 200 cases and almost half of those are now settled. The vast majority of disputes with taxpayers working in media industry are settled by agreement, he said.
So far, in 50 per cent of payroll cases where the CEST has been used, the determination has been that this engagement is outside IR35, said Harra. To make CEST give more comprehensive determinations beyond the 80 per cent that it is currently achieving would unfortunately involve making it more complex for everyone to use.
Chartered Tax Adviser Craig Mackinlay, Conservative, who had earlier remarked that he was wearing his CIOT tie for the hearing, also asked about the application of blanket bans by companies. Harra replied that any engager that makes such blanket determinations and brings people within the rule who do not need to be within it are incurring a cost to themselves, because employers’ NICs are then due. “We hear feedback as well from workers who claim that it is happening. When we look at the evidence, first of all from the research into the public sector, we didn’t actually find it.”
Tax complexity / alignment of employment taxes
Sir Geoffrey Clifton-Brown said if we could ‘narrow the arbitrage of the NICs a little bit closer’, some of the incentive for people to try to avoid IR35 would be reduced. Is there any long-term thinking that you should more align the two sections of employed and self-employed workers, or is that simply impossible, he asked.
Jim Harra replied: “There is no doubt that the differential tax liabilities between the employed and self-employed and absent IR35s between incorporated and unincorporated create big incentives in the tax system and create boundaries that we then have to police the compliance of. Our lives would be a lot simpler and more straightforward if there was equal taxation right across those three areas.”
Nicole Newbury explained to Clifton-Brown that HMRC’s best judgment is that quite often contractors work for a number of organisations and therefore HMRC apply an 0T tax code to calculate the liability from the engaging organisation, ‘but in every case where we are able to trace the individual we will apply the correct tax to it’. (Letters in an employee’s tax code refer to their situation and how it affects their Personal Allowance. The 0T code tax is deduced from all income - there is no Personal Allowance. This happens when an employee has not given you a P45 or enough details to work out their tax code, or when their Personal Allowance has been used up.)
Do you make it clear on your assessment of that individual that you have applied the 0T tax code and that you have assumed that they do not have any personal allowance left, but that if they do, they would be entitled to reclaim it, asked Clifton-Brown. Newbury replied that HMRC’s work is with the engaging organisation, not the individual. If the public sector body has the information, HMRC will then write out to the contractors to say that they might be due a refund, ‘but the information has not been there to enable us to do that’. She also said there is no way HMRC can advise clients or make sure that companies advise them that this is the way their tax has been treated.
Craig Mackinlay asked why HMRC had opted to deal with this through public and private sector employers rather than getting HMRC to ‘go to the source’, and use their powers to investigate all those PSCs, which ‘everybody knew were not operating as they should for very many years’?
Jim Harra replied that the reality is that without an army of tax inspectors investigating workers all the time, this was not a practical way of doing things. Moving the responsibility elsewhere in the labour chain is more effective. Understanding how we make best use of intermediaries such as employers is part of the future of tax administration, added Harra.
Most public sector engagers told HMRC that they did not have to change the rates that they paid contractors as a result of the measure, said Harra.
Mackinlay asked if HMRC have a ‘lighter touch’ approach with the public sector than with the private sector. Nicole Newbury replied: “Absolutely not.”
Commenting on HMRC’s research, Meg Hillier was annoyed that in the section about impacts of the reforms on contractor recruitment and rates, every time HMRC come up with a figure, they say, ‘but the majority disagreed’. “But some of the minorities that were having problems with recruitment and rates are quite significant. For example, a fifth of sites [a site was a public sector organisation that only dealt with contractors on one particular location] and a third of central bodies reported that it had been more difficult to fill contractor vacancies since April 2017. Similar proportions of sites, 21 per cent, and central bodies, 25 per cent, agreed that it was harder to recruit contractors with the right skills since the reform, but, you say, the majority disagreed.” HMRC’s Nicole Newbury said the economic turbulence at the moment means has been difficult for HMRC to drill down further into particular sectors.
Future reforms and CEST
Is it HMRC’s intention to have all employing businesses within the scope of these rules over time, including small businesses, asked Craig Mackinlay. Jim Harra said the Government has no plans for any further reforms here. It means there is now a cadre of PSCs that still have the obligation that is small enough for us to police, in a way that just was not practical for us when we had a quarter of a million of them to look at.
On CEST, Mackinlay observed that one of the reasons HMRC gave the committee for why it all seems to be working well and why blanket bans by the public sector in particular are not happening is that you are getting great usage of the CEST indicator tool. Do you think that some people just keep trying it, maybe changing their contract slightly and trying the tool again to try to get the answer they want, he asked.
HMRC’s Pete Downing replied: “I suspect there is a degree of that behaviour in there, where people are iterating the facts that they have put into CEST to try to get the answer they want. One of the steps we took with CEST - a delivery decision that we made - was not to attribute back to the taxpayers or engagers that are using it. That was to forestall any sense that we were using it to track people, to encourage use of the tool.” When we get the decisions in the Court of Appeal cases that we are waiting for now, we will look at whether the CEST tool needs to be changed, said Harra, but HMRC sometimes calibrate the CEST tool based on first-tier tribunal decision.
Meg Hillier said the committee’s report on this inquiry may be out by Easter
The transcript is here.
By Hamant Verma, CIOT Senior External Relations Officer