UK govt says contractors should challenge IR35 status via self-assessment

What could possibly go wrong?

The UK government has suggested IT contractors should challenge errors in their tax status and reclaim overpaid tax through self-assessment yet some experts think the plans are impractical and misguided.

Tax authority Her Majesty's Revenues and Customs (HMRC) was responding to a report by the Public Accounts Committee (PAC) criticizing high levels of non-compliance with the UK's off-payroll tax regime, IR35.

Difficulties meeting the IR35 rules, which apply to many IT contractors, in central government reflect poor implementation by HMRC and other government bodies, the PAC said.

New IR35 rules were introduced for businesses in April 2022 following a year's delay caused by the COVID-19 pandemic. The rules were introduced in the public sector in 2017.

The report also expressed concerns that it is too difficult for workers to challenge incorrect status determinations.

"The absence of a clear definition of self-employment, and limited access to relevant personal information for each contractor, can make it challenging for hiring organisations to make status determinations confidently," the report said. Contractors could challenge decisions with the hiring organisation, but they have no independent route to appeal.

In response, HMRC said contractors who still disputed the tax determination after a direct appeal to the employer could reflect their own tax assessment in their Self-Assessment return.

"HMRC has 12 months from the date the return is received to open an enquiry, during which it may consider whether the employment status is correct," the department said.

"Where HMRC disagrees with a customer's Self-Assessment, all customers have the right to have the decision reviewed, and to appeal to an independent tribunal."

Dave Chaplin, CEO of tax compliance firm IR35 Shield, rubbished the move.

"To suggest a worker can seek to reclaim monies from an incorrect assessment via the self-assessment tax system is misguided, because the worker cannot reclaim the bulk of the deducted monies, which is employers' [National Insurance]," he said.

"Also, to suggest the worker can appeal to a tax tribunal is absurd, because the cost of doing so will far outweigh the tax and could take up to 10 years to resolve as we have seen happen. The government's comments claiming there are 'appeal routes' is impractical nonsense and highlights the impediment to natural justice inherent in the IR35 reforms."

In February, HMRC compliance director Nicole Newbury acknowledged that businesses implementing blanket bans on contracting personal service companies (PSCs) could be found not to have complied with IR35, but challenging decisions could be a lengthy process.

Chaplin was also unimpressed with HMRC's effort to iron out problems with the contractor tax system.

What is IR35?

IR35 is a reform unveiled in 1999 by the UK tax authorities. The latest regulation change – which came into force in April 2021 – forces 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 – i.e. 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 are able to slash their tax bills by billing for their services through Personal Service Companies (PSCs), which are taxed at lower corporate rates.

The measures first came into effect in the UK 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.

Over in the US, there are two main types of contractors: those who fall under 1099 (Form 1099-Misc), and those who fall under Form W-2, with the latter being similar to IR35 in the UK. However, there are major differences. According to contractor and freelancer news site, contractor.com, the main difference is "in the UK, the contractor is financially punished if found to be a disguised employee, whereas in the USA, it's the client that is penalized.

The National Audit Office, an independent public spending watchdog, had already pointed out that HMRC does not offset tax due from the employer against any tax already paid by the contractor or PSC. The effect was that individuals could be taxed twice depending on the IR35 status judgement. The PAC recommended that HMRC does not end up taxing the same income twice or unwittingly contribute to workers not paying their fair share in tax.

In response, HMRC said it already implemented a process to reduce the circumstances where it collects tax twice in respect of the same engagement in cases of non-compliance. "Where HMRC has sufficient information to identify them, it will notify the worker and their intermediary if they are entitled to claim a repayment of taxes overpaid in relation to the specific off-payroll working engagement."

But Chaplin said: "HMRC claims it has a process to reduce collecting tax twice but will only do so if it has sufficient information to identify the worker. In my view, this is not strong enough; there should be a statutory requirement for HMRC to locate and process the refund. If HMRC fails to do so, the 'fee-payers' bill should be reduced by a deemed amount of tax paid."

Seb Maley, CEO of IR35 insurance firm Qdos, said: "The PAC provided a damning assessment of IR35 reform, with the report calling on HMRC to make changes to these flawed rules. And while HMRC has agreed with the recommendations made, the tax office is merely promising to review and research these issues further.

"Ultimately, this response lacks a concrete promise to resolve several of the fundamental issues resulting directly from the introduction of IR35 reform – whether that's to ensure contractors have a fair shot at overturning unfair IR35 determinations or to give businesses every chance to comply with the rules.

"It's a disappointing – albeit predictable – response that we've seen far too often from the government whenever it's pressed on IR35."

The PAC reported that government departments were having difficulty interpreting the tax rules. "Central government is spending hundreds of millions of pounds to cover tax owed for individuals wrongly assessed as self-employed. Government departments and agencies owed, or expected to owe, HMRC £263 million in 2020–21 due to incorrect administration of the rules," the report said.

The NAO has found that 2020-21 financial statements of government departments showed the Department for Work & Pensions (£87.9m), Ministry of Justice (£72.0m), Home Office (£29.5m), Department of Environment, Food & Rural Affairs (£19m), and NHS England (£4.2m) all made errors in IR35 assessments.

HMRC said it had undertaken "an extensive programme of customer education and support during the implementation of the reforms, and already provides additional support to address inherent challenges faced by customers where these are identified." ®

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