Defra and MoJ hit with £120m IR35 tax bill despite using HMRC guidance

The Ministry of Justice and the Department for Environment, Food and Rural Affairs (Defra) have received tax bills totalling just over £120m for IR35 non-compliance, despite following official HM Revenue & Customs' (HMRC) guidelines and training.

In its Annual Report and Accounts for 2020-21, published on 16 December, the Ministry of Justice (MoJ) said: “HMRC has audited the department’s IR35 assessments (made between 6 April 2017 and 5 April 2021) and has challenged our interpretation of the rules, asking us to revisit employment status determinations made for all off-payroll workers where our hiring managers had concluded their workers could send a substitute to deliver work instead of themselves.

“Following the compliance audit, HMRC concluded that incorrect determinations were made by the department. As the public sector engager is liable for any tax and NIC [National Insurance Contributions] as a result of an incorrect determination, the department incurs a liability of £72.1m to HMRC. This includes interest of £4.5m.”

This figure rivals the £87.9m tax bill received in respect of “historic” IR35 status contractor assessment errors made by the Department for Work and Pensions (DWP), disclosed in its accounts earlier this year.

Defra, in its Annual Report and Accounts, said: “HMRC launched an enquiry into Defra’s compliance with the off-payroll working (IR35) rules in relation to contingent labour in 2019. The enquiry is ongoing, but it has determined there have been instances where contractors were incorrectly assessed as out of scope.

“Defra has reassessed the majority of current contractors and estimated that tax and national insurance lost between 6 April 2017, when the rules came into force, and 31 March 2021, for these contractors, to be £19m. Defra accepted there was a liability and agreed with HMRC to make a payment of £19m to HMRC in March 2021.”

However, later in the report, the department said: “Since 31 March 2021, work on reassessing contractors’ IR35 statuses has continued. This has led to additional contractors being reassessed as inside IR35. In addition to this, some of the assumptions made in the initial calculation have recently been clarified with HMRC, which will also affect the liability.

“The remaining liability now stands at £48m, based on 6% of contractors remaining outside IR35. The provision remains based on 22% being outside IR35 as this was the position at 31 March 2021. Work is continuing to agree the final liability with HMRC.”

Dave Chaplin, CEO of tax compliance firm IR35 Shield, said that Defra, as one of the largest government organisations, would have received considerable help and guidance from HMRC for implementing the off-payroll reforms. Defra had also committed to using HMRC’s Check Employment Status for Tax (CEST) tool - touted as the most accurate way to assess contractors' IR35 status.

“According to HMRC's published manuals, that approach should have ensured Defra met the standard of reasonable care. But this is apparently not the case as they have been accused of carelessness,” he said.

Defra stated in its report that the department’s reassessment of the status of all its contractors from the introduction of the IR35 legislation in April 2017, which required public sector bodies to assess off-payroll workers’ status for tax, “assumes that HMRC would deem any incorrect assessments as careless, but the investigation is still to be finalised”.

Chaplin told Computer Weekly: “The same government organisation, HMRC, that was responsible for both educating government bodies and then enforcing the rules, is now issuing Defra, one of its ‘customers’, with a £48m tax bill. This is a farcical situation – had this happened in the private sector, the firm providing the advice and guidance would have a claim for negligence on its hands. Instead, HMRC, who gave the advice, is issuing Defra with a multimillion-pound bill.”

Chaplin said the Ministry of Justice appears to have over-relied on the “substitution part of CEST”. The MoJ report makes clear a difference of viewpoint between the department’s “hiring managers” and HMRC in respect of the principle of substitution – “where our [MoJ’s] hiring managers had concluded their workers could send a substitute to deliver work instead of themselves”, thereby putting them in the category of being self-employed contractors providing a service.

HMRC also accused the MoJ of being "careless" in its application of the off-payroll working rules. The report added: “As a result, [HMRC] imposed a penalty of £15m. That penalty has been suspended for three months subject to certain conditions and is therefore not included within the losses total. The conditions relate to meeting the department’s notification and filing obligations, a 100% assurance check on all out-of-scope determinations, and improved training of hiring managers.”

Chaplin commented: “If you are the Ministry of Justice, you should know exactly what you are doing. For HMRC to accuse the Ministry of Justice of negligence is massive.”

That government departments seem to be getting IR35 compliance wrong, despite using HMRC’s CEST tool, bodes ill for private sector companies, that have been subject to the same legislation since April 2021, added Chaplin.

“We are seriously concerned that private sector firms have used the CEST tool, thinking it will protect them, when it won’t. HMRC has only started to open compliance checks in the private sector," he said.

“We have always said that taking tax advice from the organisation that is responsible for issuing the tax bills presents considerable risk. With the DWP being hit for £89m, the Home Office for £29m, and now Defra and the MoJ for £48m and £72.1m, this is now undoubtedly the case.

“The scale of errors produced by the CEST tool here is alarming. Defra followed HMRC’s guidance and used CEST in good faith, resulting in it determining that 85% of the contractors were ‘outside IR35’.

“It has been widely reported many times that CEST is fundamentally flawed and misaligned with the law. This is cast-iron proof of those accusations. Many firms ditched using CEST quite some time ago for these reasons, and we suspect it will either become obsolete in use or forced to be withdrawn by HMRC.”

IPSE, the Association of Independent Professionals and the Self Employed, said the examples of MoJ and Defra show that more clarity is still needed around IR35.

“The fact that two major government departments have run into trouble with their IR35 compliance shows just how complicated and confusing the regulations are,” said Andy Chamberlain, director of policy at IPSE.

“Even with guidance, support and training from HMRC, the MoJ and Defra have not made accurate status determinations. Private sector organisations that aren’t as connected to HMRC will almost certainly find it equally challenging.”