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IR35: HMRC claims ‘potential’ legislative change in pipeline to address settlement offset issue

HMRC claims work on a ‘potential legislative solution’ is underway to ensure it does not collect more tax than is due when end-user organisations are found to have made errors in determining the IR35 status of their contractors

HM Revenue & Customs (HMRC) has confirmed a “potential” legislative solution is in the works to address a long-standing issue that has seen the government agency accused of “over-collecting” tax from public sector bodies that have fallen foul of the IR35 rules.

Details of this work appeared in a 248-page document, published in early December 2022 by HM Treasury, setting out government responses to various sessions held by the Committee of Public Accounts over multiple years.

Several pages of the report are given over to providing an update from HMRC on how it is progressing with implementing a series of recommendations it received in 2022 from the National Audit Office (NAO) and the Public Accounts Committee (PAC) on how to improve its implementation of the IR35 reforms.

The NAO report, published in February 2022, specifically focused on HMRC’s handling of the public sector roll-out of the IR35 reforms in April 2017 and flagged an issue with the amount of tax HMRC collects from non-compliant public sector bodies.

The report confirmed, at the time of its release, that a total of £263m tax had been paid to HMRC by non-compliant government departments. It also went on to point out that when calculating how much tax is due, the agency is failing to take into account the amounts the affected departments’ contractors have already paid in corporation and dividend tax.  

What are the IR35 reforms?

The IR35 reforms were first introduced to the public sector in April 2017 before being extended to medium-sized and large private sector firms in April 2021, and saw contractors cede control for determining how they should be taxed to the end-user organisations that engaged them.

Previously, contractors were able to self-declare whether the work they do, and how it is performed, meant their engagements were in or out of scope of the IR35 rules, but – according to HM Revenue & Customs (HMRC) – this system was being abused by some to deliberately misclassify themselves as working outside IR35 to artificially minimise the amount of tax they pay.

This is because engagements that were classified as being inside IR35 meant the contractors concerned would be treated as employees for tax purposes and would be expected to make the same pay-as-you-earn (PAYE) and NICs as permanent employees.

The roll-out of the changes to both public and private sectors brought about huge amounts of upheaval for IT contractors as some end-hirers sought to side-step the additional administrative burden this shift in responsibility put on them by introducing contractor hiring bans.

Other organisations decided to issue blanket determinations, whereby all contractors were deemed to be working inside IR35 as a means of ensuring compliance and to reduce the risk of being saddled with a sizeable tax bill later down the line for incorrectly assessing the tax status of their contractors.

To this point, several central government departments have found themselves subject to compliance reviews by HMRC that have seen them hit with penalties and multimillion-pound tax bills for making IR35 status determination errors.

“[HMRC] does not offset the total amount of tax against any tax the worker or their PSC [Personal Service Contractor] 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,” the report stated.

The matter has been dubbed the “settlement offsets issue” by various contracting market stakeholders and is one of several areas of concern the NAO report called on HMRC to address.

Another relates to the fact that once a non-compliant public sector body accepts its IR35 status determinations are incorrect, the affected contractors become entitled to claim back the tax they have already paid. But, as claimed in the NAO report, this is not something HMRC has actively made contractors aware of.

In the Treasury report, HMRC provided an update on how its work to address both these matters is progressing, but stopped short of providing a resolution date for either of these related issues.

“HMRC continues to engage with its working group of external stakeholders on options for a potential legislative solution to address the issue of taxing the same income twice,” the organisation said in its response.

“In parallel, the department is continuing to review and refine its process for notifying workers and their intermediaries about overpayments of tax, and their route to reclaim these amounts, where it has sufficient information to identify them.

It added: “HMRC will keep the committee informed as progress is made and update the target implementation date at the earliest opportunity.”

The settlement offsets issue may have been brought to wider, more public attention in the wake of the NAO report, but Computer Weekly is aware that HMRC has been under pressure for several years to take action on the matter.

A representative from The Institute of Chartered Accountants in England and Wales (ICAEW) wrote to HMRC in August 2020. The letter – seen by Computer Weekly – stated: “ICAEW has been concerned for some time about offsets.”

The letter also set out a series of suggested workarounds that would require “no change to the [off-payroll] legislation to push through”.

The quarterly IR35 Forum, which is a group of external stakeholders that HMRC oversees who are tasked with finding ways to make the off-payroll legislation work more effectively, has discussed at multiple meetings how best to address the issue.

As confirmed by Computer Weekly, the settlement offsets issue was discussed by the IR35 Forum during multiple meetings throughout 2021, but progress on finding a solution to the problem appears to be proceeding at a glacial pace.

The minutes from the IR35 Forum’s June 2021 meet-up feature an acknowledgement from HMRC about a standalone session for the group to meet and discuss the settlements issue that reportedly took place in February 2021, for example.  

However, the minutes from that meeting then go on to state that a “disagreement between HMRC and members” has emerged about their preferred methods of resolving the matter.

The contents of the September 2021 meeting minutes suggest this disagreement hinges on the fact the forum members want HMRC to pursue a “legislative solution” to the problem, but the government department appeared reluctant to go down that route at that time.

“HMRC… acknowledged that the current position couldn’t continue unaddressed… [and] explained that they had presented the issue to their programme board to assess the available options,” the September 2021 minutes stated.

One of the suggested options is something HMRC has termed the “notification procedure”, whereby contractors who are eligible to claim back tax will be contacted by the agency.

“Recognising that HMRC should not be collecting more tax than is due and that there is currently no clear and reasonable way of implementing a legislative solution, the programme board has decided to seek approval from HMRC’s executive committee and the responsible minister to implement the notification procedure,” the minutes continued.

“HMRC will also seek approval to continue to explore future legislative options with stakeholders. HMRC understands that this is not the solution that forum members want, who strongly expressed that a legislative solution was needed now.”

The Chartered Institute of Taxation (CIOT) also sought to draw attention to the issue in its response to the House of Lords Finance Bill Sub-Committee inquiry into the roll-out of IR35 reforms to the private sector in November 2021.

Its communication makes reference to the lengthy discussions the IR35 Forum members have had about the offsets issue, while also confirming the matter has also been “the subject of correspondence with the Financial Secretary to the Treasury”.

“We believe that HMRC [has] a statutory duty to ‘make sure everyone pays the right amount of tax’ pursuant to the HMRC Charter – and that includes an obligation to ensure fairness in determining who pays what in [off-payroll working] settlement cases,” it stated.

“In our opinion, a legislative resolution is required to allow for tax already paid by [the contractor] to be offset against tax assessed as due from the business.”

Dave Chaplin, CEO and founder of tax compliance firm IR35 Shield, told Computer Weekly that, while it was encouraging to hear there is a plan to fix the offsets issue, the fact there is still no concrete delivery date in sight is concerning.

“HMRC has been aware of the problem for many years, but we are still waiting for a legislative fix,” he said.

“Currently, the legislation makes a hirer pay all the taxes, of around 50% of the total costs of hire. Perversely, the contractor can obtain a full refund for all taxes they have paid so they pay nothing.

“This is simply not right and until this anomaly is fixed, UK plc will continue to be penalised and freelance contractors and others in the supply chain will not be taxed fairly. It must be sorted out in tax law as a matter of urgency.”

He added: “And whilst this flaw remains, all those contractors involved in historic public sector contracts, where HMRC issued bills of over £250m, can now reclaim all their taxes and pay an effective tax rate of zero. This hole needs urgently plugging.”

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