IR35 reforms: PAC concerned HMRC’s ‘tough’ enforcement is harming contractors

The Public Accounts Committee (PAC) has concerns that HM Revenue & Customs’ (HMRC) “tough approach” to enforcing the IR35 tax avoidance rules is deterring companies from using contractors.

The admission features in a 27-page assessment by PAC about HMRC’s performance over the course of 2022-2023, which concluded that the government tax collection’s overall level of customer service has reached an “all-time low” during the reporting period.

The report outlines PAC’s concerns about how HMRC’s approach to IR35 might be “deterring legitimate economic activity” by making private and public sector organisations wary of hiring contractors due to a “lack of confidence” in how to comply with the rules.

As previously reported by Computer Weekly, the IR35 rules were subject to reform in the public and private sector in April 2017 and April 2021, respectively, due to concerns the way they worked might be contributing to tax avoidance within contracting circles.

This is because, before the reforms were introduced, contractors were responsible for determining for themselves if they should be taxed in the same way as salaried employees (inside IR35) or off-payroll workers (outside IR35) – based on the work they do and how it is performed.

According to HMRC, this system of self-determination was misused by some contractors to deliberately and artificially minimise the amount of employment taxes and National Insurance Contributions (NICs) they had to pay by declaring themselves as working outside IR35.

As a result, the reforms introduced a shift in responsibility so that end-hirers were now tasked with assessing the employment status of each contractor their organisation engaged and, in turn, deciding if they were working inside or outside IR35.

As extensively documented by Computer Weekly, the shift in responsibility led to a sizeable increase in administrative burden for end-hirers, resulting in many public and private sector organisations banning the hiring of contractors or issuing mandates that all of their contractors be considered inside IR35 for compliance purposes.

According to figures shared by PAC, the reforms have resulted in between 150,000 and 200,000 contractors being moved onto private and public sector payrolls, which the committee flagged as concerning.

“We are concerned that a lack of confidence in how to apply the rules, together with HMRC’s tough approach when taxpayers make mistakes, is deterring companies from using contractors, unnecessarily,” the report stated.    

Elsewhere in the report, HMRC said it “did not accept that its guidance [on how to apply IR35] was not clear”.

Even so, to address this concern, PAC said HMRC should “assess the impact of [its] approach to administering IR35 reforms on the use of contractors in different sectors”, and has given it two months to respond to this recommendation.

This is not the first time PAC has called into question HMRC’s handling of the IR35 reforms, as it published a report in May 2022 that claimed the department’s “rushed implementation” of the public sector reforms had led to “widespread non-compliance” that had resulted in several central government departments owing hundreds of millions in unpaid tax.  

Dave Chaplin, CEO of tax compliance company IR35 Shield, backed the PAC’s findings, and said end-hirers are deterred from using contractors out of fear they might accidentally fall foul of the IR35 rules and ended up saddled with a large tax bill.

“The Public Accounts Committee’s scrutiny over the implementation of the IR35 reforms correctly identified that the new rules are deterring legitimate economic activity, which aligns with what we are seeing on the front-line, particularly in the media sector,” he said.

“We are seeing broadcasters seeking to misclassify people as ‘deemed employees’ based on risk, rather than the law, because the broadcaster fears HMRC will tell them they’ve got it wrong and issue them with a tax bill.

“We currently have a ‘bad policing’ problem with IR35, where the IR35 tax police are writing their own rule book, and not following the law, leaving taxpayers with the only option of appealing to an expensive and costly tax tribunal, which many cannot afford.”