IR35 reforms: HMRC slammed for ‘over-collecting tax’ from non-compliant public sector bodies

Contractors working for public sector bodies that have fallen foul of the IR35 rules could be entitled to a pay-out from HM Revenue & Customs (HMRC), it has emerged.

The government tax collection agency has come under fire for failing to publicise that contractors could be entitled to reclaim tax they have previously paid if the public sector organisation they work for has been landed with a tax bill for failing to implement the IR35 rules correctly.

The IR35 reforms were rolled out to the public sector in April 2017 as part of a push by HMRC to clamp down on disguised employment among personal service company (PSC) contractors.

The changes saw public sector contractors cede responsibility for determining how they should be taxed to the organisations that hired them.

Previously, it was down to contractors to decide whether the work they did and how it was performed meant they should be taxed in the same way as salaried employees (inside IR35) or as off-payroll workers (outside IR35).

According to HMRC, letting contractors decide for themselves how they should be taxed resulted in thousands of individuals deliberately misclassifying themselves as working outside IR35 to minimise their employment tax liabilities. This practice had, it is claimed, cost the Treasury £440m in unpaid tax during the 2016-17 financial year.

A report by the National Audit Office (NAO) into how HMRC handled the roll-out of the IR35 reforms in the public sector confirmed that a total of £263m had been paid to HMRC by non-compliant government departments and agencies to date.

However, the report went on to point out that when calculating the amount of tax these non-compliant public sector bodies owe, HMRC is failing to take into account the corporation tax or value-added tax the contractors working for these organisations will already have paid.

“HMRC collects the amount due in accordance with the law at that time,” said the report. “It does not offset the total amount against any tax the work or their PSC already paid and told us this was not allowed within the current legislation. This means that HMRC collects more tax in total than is due.”

Also, once a non-compliant public sector body accepts that its IR35 status determinations were incorrect, the contractor becomes entitled to claim back the tax they have already paid – but this entitlement is not something HMRC actively promotes, the report said.

“If contractors do reclaim this tax, they in effect pay no taxes on that income because these are borne in full by the non-compliant public body,” said the NAO report. “However, HMRC does not actively promote this and it is unclear how many workers reclaim their taxes in practice.”  

Seb Maley, CEO of IR35 compliance consultancy Qdos, seized on the fact that the NAO report said HMRC has no plans in place to correct the fact that it is collecting more tax than is due when non-compliance is detected.

“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,” he said. “HMRC won’t offset the amount and, to make matters worse, there are no plans to address this, which is frankly wrong.”

Dave Chaplin, CEO of contractor compliance consultancy IR35 Shield, told Computer Weekly the situation was a “disgrace”.

“The whole tax offsets point is a disgrace and fails to align with the principles of equitability in the tax system,” he said. “Effectively, it means HMRC is double-taxing the same money.

“So, £263m was paid by a government body to another one, and now all those contractors can reclaim their tax back – that would mean a loss in tax due to their investigations.”

In a statement to Computer Weekly, a HMRC spokesperson hit back at the NAO report, claiming it was “incorrect” to say that HMRC “over-collects tax”.

The statement said: “HMRC can only collect what is due in law and, as such, HMRC collects the correct amount of tax due under the legislation at the time it is collected.

“However, where an error is later discovered, the result is that amounts that were paid correctly at the time are no longer due, as the income should have been subject to PAYE instead.”

And although the NAO report claimed HMRC has no plans in place to address the double-taxation issue, the spokesperson said the agency was “already looking at how it can notify contractors that they may have overpaid tax on their off-payroll engagements as a result of a compliance check”.

The spokesperson added: “Where HMRC has sufficient information, it will contact contractors regarding any potential overpayment of tax.”

HMRC has been under pressure from members of the IR35 Forum for some time now to address how it offsets the tax already paid out by contractors in instances where the public sector bodies they were working for are found to have not complied with the IR35 rules.

The Chartered Institute of Taxation has included a call for the matter to be addressed in its submission to the House of Lords Finance Bill Sub-Committee’s ongoing inquiry into IR35 reforms, which concluded its call for evidence in November 2021.

The institute said, in its submission, that it was concerned that the tax already paid out by contractors or their limited companies is not being offset against the tax due from an organisation that is found to have incorrectly implemented the IR35 rules.

“This matter has been discussed at length with HMRC via the IR35 Forum and has also been the subject of correspondence with the financial secretary to the Treasury,” it said.

“In our opinion, a legislative resolution is required to allow for tax already paid by the PSC/worker to be offset against tax assessed as due from the business. This would reflect the position that already applies where there is misclassification of workers in cases not involving PSCs.”   

In the meantime, Maley said contractors who think they might be entitled to make a claim should get in touch with HMRC to pursue the matter in full. “It’s a huge hole in the legislation, but claiming back tax that contractors have paid is certainly possible, albeit long-winded,” he said. “The benefit, though, is that if a contractor was successful, all the income reclaimed would be tax-free.”