Updated Her Majesty's Courts & Tribunal Service has been forced to pay the UK taxman £12.5m due to incorrect assessments regarding the employment status of contractors under controversial IR35 rules.
Disclosed in the court service's annual report [PDF], the payments were a result of a challenge from Her Majesty's Revenue & Customs (HMRC) to the Ministry of Justice's handling of IR35 rules between 6 April 2017 and 5 April 2020, which had concluded workers were operating outside of the off-payroll working rules.
Under IR35, contractors, many of whom work in IT, that are "deemed employees" by HMRC need to pay income tax and National Insurance as though they are employees but are not entitled to benefits such as holiday or sick pay.
The government introduced changes to the IR35 rules that came into force in April 2021 and made large and medium-sized businesses responsible for determining the employment status of contractors for tax purposes, rather than the contractors themselves.
What is IR35?
IR35 is a tax reform that was unveiled in 1999 by the UK tax authorities. The latest regulation change will force medium and large businesses in the UK to set the tax status of their contractors and freelancers. Previously this was set by the contractors themselves.
Contractors found to be within the scope of the legislation – ie, inside IR35 – will have to pay more tax than they might expect.
The reforms are part of the government's crackdown on so-called disguised employment, where workers behave as employees but avoid paying regular income tax and national income contributions by billing for their services through personal service companies (PSCs), which are taxed at lower corporate rates.
The measure came into effect in the public sector in 2017. The British government hoped the reforms would recoup £440m by bringing 20,000 contractors in line.
HMRC reckons that only one in 10 contractors in the private sector who should be paying tax under the current rules are doing so correctly. It estimates the reforms will recoup £1.2bn a year by 2023.
In this case, the court service workers seem to have been miscategorised because of its use of the HMRC's Check Employment Status Tool (CEST), according to Seb Maley, CEO of Qdos, an advisory firm for contractors.
He pointed out that the Department of Work and Pensions had admitted an £87.9m IR35 liability and the Home Office paid £33.5m under similar circumstances.
"Given that HMRC's fundamentally flawed CEST was used to decide the IR35 status of contract workers, I'm not in the least bit surprised that mistakes have been made," he said.
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"Here we have proof yet again that the taxman's very own IR35 tool threatens compliance rather than ensuring it. Businesses should avoid it altogether or at the very least get a second opinion on every answer it provides."
The CEST tool has been slammed for returning inconclusive responses for one in five of the million-plus times it was called upon during a 16 months period.
Dave Chaplin, CEO of IR35 Shield, said: "HMRC's CEST tool is failing fast and now we are hearing of yet one more government department, because it has relied on CEST to assess its contracting workforce. It is crucial that once you hire a worker on an 'outside IR35' basis that you continue to monitor the status throughout the engagement. Regular checking and gathering contemporaneous evidence are crucial in forming a pre-emptive defence."
Her Majesty's Courts & Tribunal Service has been contacted for a response. ®
Updated to add at 15:48 UTC:
A Ministry of Justice spokesperson said: "Strict checks and extra controls have been introduced to ensure that tax rules are applied correctly."