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HS2 sets aside £9.5m to cover cost of IR35 non-compliance

HS2 has become the latest public sector entity to have fallen foul of the IR35 rules, with its accounts confirming that it is anticipating a tax bill of £9.5m for failing to assess the status of contractors provided to it by a third party

HS2, the public body responsible for developing the UK’s high-speed rail network, has set aside £9.5m to cover the cost of suspected non-compliance with the IR35 tax avoidance legislation, its public accounts confirm.

The organisation, which is classified as an executive non-departmental public body and sponsored by the Department for Transport, said its “historic” compliance with the IR35 rules is the subject of an ongoing review by HM Revenue & Customs (HMRC) that started in May 2022.

That work will confirm exactly how much tax HS2 must pay to cover the cost of IR35 compliance failings made between April 2017 and November 2020, Computer Weekly has learned.

The organisation confirmed in its accounts that £9.5m has been set aside pre-emptively to cover any tax owed, which means a total of £272.5m worth of IR35 compliance errors have now been made by public sector organisations, with the largest to-date being the £87.9m tax bill the Department for Work and Pensions got landed with by HMRC.

The reworked IR35 Off-Payroll working rules, that came into effect for HS2 and the rest of the public sector in April 2017, saw contractors cede control to the end-user organisations that engage them for determining how they should be taxed based on the work they do and how it is performed.

Contractors whose engagements are assessed as being within scope of the rules (known as inside IR35) are treated as employees for tax purposes, meaning they are liable for Pay As You Earn (PAYE) and National Insurance Contributions (NICs), but are not eligible to receive workplace benefits.

Meanwhile, individuals who are determined to be out-of-scope of the rules are classified as working outside IR35.

The HS2 accounts cover the 12 months to 31 March 2022 and state that an internal review, coupled with additional guidance from HMRC, revealed HS2 did not carry out employment status determinations on a number of contractors because they were supplied by a third-party provider.

“During 2020, internal checks and additional HMRC guidance highlighted some cases of workers who were engaged through other suppliers that had not been appropriately reviewed,” the accounts stated.

“An estimated liability has been identified through an internal review of workers operating between April 2019 and March 2021 using a calculation of PAYE and National Insurance that would be due on assumed earnings. This figure has been extrapolated back to April 2017.”

Computer Weekly understands the matter concerns a limited number of contractors HS2 used during this time, who were engaged through a third party on a “contracted out services” basis.

In this kind of setup, responsibility for determining how the contractors should be taxed falls on the third-party supplier rather than the end-user organisation they end up working for.  

“Where you enter into a contract for a genuine service or fully contracted out service, [the public sector body] will not be the client for the purposes of the off-payroll working rules. Instead, the client will be the service provider because they are the person the work is providing their services to,” said HMRC in an August 2021 Employer Bulletin guidance document, warning of the pitfalls of contracted out working setups.

As detailed elsewhere in that bulletin, contracted out services are tricky to define and this can leave end-user organisations, such as HS2, exposed. “Whether a contract is for a fully contracted out service is a question of fact based upon the commercial reality of the arrangements. Where there is uncertainty as to who the true client is, consideration should be given to the nature of the relevant contracts and working practices.”

In a statement to Computer Weekly, a spokesperson for HS2 said the organisation took action in 2020 to ensure it complies with the IR35 rules. “HS2 takes our obligations to comply with tax legislation extremely seriously and is working with HMRC on a compliance review to assess any historic tax liability. Since 2020, HS2 has implemented new processes to ensure we meet all liabilities under the Off Payroll Working Legislation.”

Dave Chaplin, CEO of contractor tax compliance firm IR35 Shield, told Computer Weekly the case highlights why it is so important for end-hirers to do due diligence when they have a consultancy providing contractors included in their supply chain.

“Firms that are engaging with consultancies should carefully examine their arrangements, and typically the answer is found in the contract between them and the consultancy,” he said.

“It’s essential that the hirer, in this instance HS2, conducts due-diligence to ensure that the consultancy is providing wholly outsourced services, and not labour.

“If the consultancy is acting like an employment business, then the hirer is the ‘client’ for off-payroll working purposes and responsible for classifying the contractors. If the client – HS2 in this case – has not issued determinations to the consultancy and workers, then it is also the fee-payer and liable for the tax.

“At IR35 Shield, we have seen many genuine consultancy arrangements in practice, but the legacy paperwork is more akin to one of an agency providing labour, which can be fatal in an IR35 investigation.”

The annual report states that once HMRC’s compliance review is completed, HS2 will be investigating if there is a cost that can be recovered from its suppliers to offset the amount of tax it has to pay HMRC – but Chaplin is not convinced that will work.

“For HS2, they will be saddled with the entire tax bill, and the contractors earnings will now be net of tax, due to the flaws in the legislation. The overall effect is that the Treasury will lose money,” he said.

As detailed in its 2020-2021 accounts, which it filed on 5 August 2022, HS2 engaged 294 contractors during the 1 April 2021 to 31 March 2022 period that were paid more than £245 a day, and 20 of these individuals were classified as working outside IR35.

The report states that HS2 used HMRC’s online Check Employment Status for Tax (CEST) tool in combination with the tax collection agency’s guidance to decide how the contractors it engages should be taxed.

For a “clearly project-based” initiative, the number of contractors classified as being inside IR35 is curious, continued Chaplin: “Contrary to HMRC’s assertions during the consultation phase [for CEST] that roughly a third of contractors would be inside IR35, in this instance HS2 has classified 93.2% of them as deemed employees. This appears to be a significantly large number.”

It is also worth noting, he added, that the deputy chair of HS2 is Jon Thompson, who was responsible for overseeing the roll-out of the IR35 reforms during his time as CEO of HMRC.

“If Jon can’t get IR35 right, who can?” he said. “It’s is one more shining example to support calls, along with a growing plethora of evidence to ditch a legislation that is having a hugely damaging impact on contractors, the firms that hire them and the economy as a whole. And the fact HS2 is one more public sector organisation that is facing a tax bill in a long line of others just proves the legislation is unworkable.”

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