IR35 tax changes were introduced in April 2021, as medium to large businesses became required to assess the tax status of contractors and self-employed workers they hired. This mirrored a system that was in place in the public sector since 2017 and it brought with it rising costs, limiting the usage of freelancers as a result. The introduction of new IR35 legislation proved controversial and the complex rules have caught the Government out on a number of occasions.
In late July, the DWP was issued with a £87.9million tax bill, as a result of incorrectly determining the IR35 status of contractors since the 2017 changes.
Following this, the Home Office faced a £33.5million penalty for “careless” IR35 failings and the HM Courts & Tribunal Service was handed a £12.5million tax bill.
Dave Chaplin, the CEO of compliance solution IR35 Shield, commented on these fines: “The latest Government IR35 casualties have all fallen foul of the much-maligned and fundamentally flawed HMRC Check Employment Status for Tax (CEST) tool and serve to highlight that CEST exposes those who use it rather than provide them with any protection. “CEST is not the law and HMRC has created its own rule book – don’t be duped. Those using it are making themselves hostage to HMRC’s alternative laws instead of being protected by the actual law. The only way to win using CEST is not to use it at all.”
Mr Chaplin went on to note it’s not possible to know which Government department could be next for an IR35 fine, Andrew Oury, a chartered accountant and tax advisor Partner at Oury Clark, explained some surprises could be on the horizon.
“There are no guesses as to who will be the next state department to be issued with a penalty; however, anecdotally, HMRC lost a number of contractors when the new rules came in. An inward look might yield a few surprises,” he said.
READ MORE: Rishi Sunak’s tax changes to force ‘shorter timeframes’ for taxpayers
“What is clear is that IR35 is long past its sell-by date. The loan charge scandal is an indirect (though many will say direct) consequence of IR35. That the Government had to change the rules to implement what they felt was the law means it was ill thought out in the first place. That they then went on to change the already changed rules reinforces the position that a sticking plaster is often not the answer when surgery is needed.
“The reworked rules pass the tax obligation to the employers. This should always have been the case. The loan charge, as is, has left the tax liability with individuals in circumstances that have resulted in lives lost and this is unconscionable.
“While no one supports tax evasion, many innocent parties (anecdotally, we have heard from the likes of teachers and nurses affected) were drawn into these schemes without their knowledge. That they are now faced with life changing tax liabilities that they never had any control over is an injustice, whichever way you look at it. And someone needs to look at it; instead of digging their heels in!”
Hugh Gunson, a Partner at law firm Charles Russell Speechlys, reiterated that, as we’ve seen, these tax penalties could be cast over a wide net.
“Any Government department could be next,” he said
“The fact that this has happened at all highlights the significant difficulties with the new rules and the serious compliance burden they place on businesses. If the Government itself is struggling to comply with its own rules, it is to be hoped HMRC will show a degree of leniency to private sector businesses that find themselves in a similar position.”
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Unfortunately, Mr Gunson went on to warn these kinds of tax penalties could be extended to already struggling businesses: “Any businesses that have not adequately prepared for the rules or put in place proper processes and procedures around them could find themselves facing additional tax liabilities and penalties. Tax penalties in particular are determined by reference to behaviour – and a failure to take reasonable care in complying with tax obligations can give rise to a penalty.
“In the context of IR35, businesses might find themselves subject to a penalty if they have not put in place proper processes and procedures to assess the employment status of their contractor workforce. Similarly, failing to properly take into account the status of individual contractors and making blanket determinations across the workforce could present issues.
“Of course, many businesses have put in place procedures and processes for assessing contractor status. However, these need to be reviewed regularly to ensure they are still fit for purpose – and businesses should also make sure they review existing engagements on a regular basis to ensure any original determination of employment status remains true and accurate. IR35 is an ongoing compliance obligation and a failure to review regularly and adapt as appropriate could also lead to penalties.
“Conversely, businesses may be able to protect themselves from the possibility of penalties by taking independent professional advice on a regular basis. Cutting corners and adopting a light-touch approach to these rules is unfortunately not an option and will likely lead to greater costs in the long run.”
Fortunately, on the flipside of this, Andy Vessey, the Head of Tax at Kingsbridge Contractor Insurance and ex-HMRC worker, explained further penalties could be rare.
Mr Vessey said: “Penalties in IR35 disputes are very rare and in all the enquiries I have been involved with, over 500, HMRC has never issued penalties. They tried in a couple of cases but were unsuccessful. This is because to be able to apply a penalty HMRC must demonstrate that the taxpayer was ‘careless’ in reaching their status determinations. ‘Carelessness’ is defined as a failure to take reasonable care and is likened to the previous concept of ‘negligence’ which was the basis for a penalty under the old system for direct taxes.
“This includes omitting to do something a reasonable person would do or doing something a reasonable person would not do. HMRC provides guidance on what is reasonable care in their Compliance Handbook 81120 and 81140. Due to the subjective nature of the tests of employment status, it is therefore difficult for HMRC to prove that a person has been ‘careless’ in making status determinations where that person has given proper consideration to the status tests and can evidence such. Penalties can also be imposed if a person or organisation deliberately fails in their IR35 obligations, i.e. knowing that a contractor is inside IR35 but nevertheless treating them as outside IR35.”
Mr Vessey went on to provide worried businesses and workers with the criteria HMRC uses to issue penalties so they can prepare: “Before HMRC will agree to suspend a penalty, conditions have to fulfil their SMART criteria:
- Specific – directly related to the individual’s or businesses’ circumstances;
- Measurable – so that the taxpayer can demonstrate that the conditions have been met;
- Achievable – so that the taxpayer can meet the conditions;
- Realistic – HMRC realises that it would be unfair to impose conditions that are unrealistic given the circumstances of the business or individual;
- Time bound – the date by which the conditions are to be met will be stated.
“The suspension conditions will relate to meeting ongoing compliance deadlines and making sure that any tax liability is settled on time during the specified period of suspension.
“If one of the conditions fails or if the taxpayer becomes liable to another penalty during the period of suspension, then the suspension will lapse and the penalty will become payable immediately.
“A period of suspension can be up to 24 months, but in the Home Office’s case, this was limited to three months which suggests that HMRC believed the Home Office’s shortcomings could be rectified in that time.
“One of the conditions that HMRC imposed was the improved monitoring and assurance not just at the point of initial engagement but throughout the contract life-cycle, which is a timely reminder to all organisations who hire freelancers to monitor the employment status of contractors with reasonable frequency.
“Should other public sector organisations be found wanting in their IR35 responsibilities, then I would expect any potential penalties to be suspended for first offences unless that department has chosen not to engage with the off-payroll rules whatsoever.”
Regardless of tax penalty fears, whether they are warranted or not, new research from the Association of Independent Professionals and the Self-Employed (IPSE) showed IR35 changes in general continue to plague those who work for themselves.
Derek Cribb, CEO of IPSE, concluded: “After a surge in the first quarter of 2021, freelancers’ average quarterly earnings have now dropped by over £2,000. This is because, just as the rest of the economy is firing up and wages are rising across the employee job market, freelancers are having to slash their own day rates. Why? The contractors’ bugbear: IR35.
“It is now clear – as we feared – that the changes to IR35 were introduced into the private sector at the very worst time: just when they were most likely to hamstring freelance recovery. Now just when there should be a surge in freelance work to support the wider economic recovery, many freelancers are finding themselves competitively slashing their day rates to fight it out over fewer contracts.
“It is not all bad news though: it is promising that there is so much optimism among freelancers about the economy and their businesses’ long-term prospects. Clearly, freelancers see a brighter future when the post-IR35 chaos settles. This also shows a path for the Government: stepping in to regulate umbrella companies and clear the mess after IR35 would not only boost the freelance sector, but also unleash its potential to drive a faster and fuller economic recovery.”
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