IR35 private sector reforms: HMRC reminds firms to use ‘reasonable care’ when applying new tax rules

HM Revenue and Customs (HMRC) has confirmed that ensuring private sector firms are taking “reasonable care” when determining how the contractors they engage with should be taxed will be part of its IR35 compliance activities post-April 2021.

The organisation has published a guidance document, designed for use by the medium to large private sector firms in scope of the IR35 reforms, to set out the approach it will take to ensure compliance with the changes once they come into effect on 6 April 2021.

From that date, all medium to large private sector organisations will assume responsibility for determining whether the contractors they engage with should be taxed in the same way as permanent employees (inside IR35) or off-payroll workers (outside IR35).

Currently, it is down to contractors to self-declare their tax status, but HMRC claims this system is open to abuse because it could pave the way for contractors to deliberately mis-classify their working arrangements as being outside IR35 to minimise their employment tax liabilities.

This is because an inside-IR35 contractor will need to make pay-as-you-earn (PAYE) and national insurance contributions, as a permanent employee would.

In the run-up to the reforms coming into play, Computer Weekly has reported on how a number of high-profile private sector companies are side-stepping the administrative burden the reforms will place on them by banning limited company and personal service company (PSC) contractors from working for them.  

In some cases, this has led to blanket bans on the use of contractors being introduced and those affected being told they can only continue working for the company in question if they are willing to take a permanent role or provide their services through an umbrella company.

In such instances, questions have been raised by the affected contractors about how that approach squares with HMRC’s insistence that companies use “reasonable care” and take a “case-by-case” approach to determining how they should be taxed.

On this point, HMRC said in its guidance document that ensuring reasonable care is being applied by companies during their compliance with the reforms will be a priority.

“We may contact you to discuss how you are applying the changes to the off-payroll working rules,” the guidance document said. “This won’t necessarily mean we believe you are not complying with the rules. It may be because we are aware the sector in which your organisation operates is impacted by the changes to the rules. For example, a sector with a high usage of PSCs.

“During these interactions, we may ask for information to confirm that you are applying the rules correctly. For example, if you are a client organisation, to check that you are taking reasonable care in making status determinations, or, if you are a deemed employer, to check whether you are deducting and paying the correct liabilities.”

Along these lines, the guidance confirms that HMRC will “challenge” tax avoidance schemes that are marketed as a way for end-user organisations and contractors to side-step the IR35 reforms or promise to minimise participants’ employment tax liabilities.

“We will take action if contractors are engaged through artificial, contrived arrangements which are claimed to avoid the application of the off-payroll working rules or result in customers paying less tax than should be the case,” said the guidance.

“This could include umbrella companies offering take-home pay rates that are too good to be true through artificial schemes that claim to disguise earnings as non-taxable payments, such as loans.”

As previously reported by Computer Weekly, the lead-up to the IR35 reforms coming into play has seen a surge in the number of umbrella companies claiming contractors that provide their services through them can take home up to 90% of their gross pay.

But such high rates of take-home pay are difficult to achieve without some form of creative accounting, which means the umbrella company could be employing disguised remuneration techniques to minimise the amount of tax its employees (the contractors) have to pay.

HMRC also restates in the guidance that it will take a “light touch” approach to penalising organisations found in breach of the IR35 rules during the first 12 months of their introduction, unless there is evidence of “deliberate non-compliance”.

This is in line with a previous statement made by the chancellor, Rishi Sunak, ahead of the original April 2020 start date for the reforms back in February 2020, when he confirmed the new rules would not be enforced in a “heavy-handed” way within the private sector for the first 12 months.

The HMRC guidance confirmed that companies will not face financial penalties during the first 12 months of the reforms for making mistakes, such as mis-classifying contractors or failing to make the correct tax deductions from their pay, providing “reasonable care” was taken when applying the rules.

“If we see that you have made a mistake, we will support you to understand how to apply the off-payroll working rules correctly,” said the guidance. “We will encourage you to self-correct errors before we consider if we need to intervene further, unless there is reason to suggest you are being deliberately non-compliant.”

Also, HMRC has moved to assure businesses that any information they acquire about how companies and contractors operate as a result of the reforms will not be used to open enquiries into their respective financial affairs for pre-2021 to 2022 tax years – “unless there is reason to suspect fraud or criminal behaviour”, the HMRC guidance document stated.

This assurance is directed at contractors that may have previously ruled their engagements to be outside IR35 and might be concerned that receiving an inside-IR35 determination from their end-client will raise a red flag to HMRC about the state of their tax affairs.

HMRC said in a statement that the actions outlined in the guidance “build on the existing commitments” the agency has made to support private sector organisations with complying with the reforms.

“Today’s publication explains how we will continue to support organisations to comply with the off-payroll working rules, once they take effect on 6 April 2021,” an HMRC spokesperson said in a statement. “It also shows what HMRC will do to identify and step in where organisations deliberately try to avoid paying what is due under rules.

“This builds on our existing commitments to a supportive approach to help organisations comply with the new rules, and the comprehensive education and support HMRC is offering to help all those affected prepare.”

Seb Maley, CEO of insurance provider Qdos Contractor, said contractors and private sector firms reading the HMRC guidance should take the agency’s “light touch” penalties claim with a pinch of salt.

“HMRC insists a ‘light touch’ will be taken with regard to IR35 compliance when the reform lands on 6 April, but this is a red herring,” he said. “Businesses won’t face penalties in the first year, but if a firm makes an incorrect IR35 decision or fails to meet its legal obligations, the tax office will still demand outstanding tax owed – and tax liability dwarfs penalties.

“Big promises have been made to clamp down on businesses that deliberately abuse the rules. But I have my doubts as to whether HMRC will actually deliver on these and put a stop to firms that blanket place contractors inside IR35. After all, no action was taken in the public sector following the roll-out of similar changes in 2017.

“On the face of it, that HMRC wants to help businesses get things right is a good thing, but the tax office needs to get its own house in order first.”

Particularly as HMRC’s online Check Employment Status for Tax (CEST) tool, which is designed to help organisations determine how the contractors they engage with should be taxed based on the work they do and how it is performed, has been repeatedly shown to be error-prone, said Maley.

“CEST is unreliable and HMRC have a dismal record in IR35 tribunals,” he added. “With reform closing in, HMRC’s compliance principles mustn’t distract businesses from preparing and doing everything in their power to make sure these changes are managed in a compliant manner.”