What can we learn from public sector failings?

We are yet to see HMRC open a compliance check under the Chapter 10 amendments in the private sector. The ‘soft landing’ period has well and truly ended so it would make sense for HMRC to increase their activity now. In fact, we are aware that end clients have been contacted by HMRC recently asking questions about their labour supply chains and their compliance processes. 

Over the past years a flurry of investigations (59 full compliance checks, to be precise) into the public sector resulted in over £263 million owed by public sector bodies to HMRC. Bodies such as the Department for Environment, Food and Rural Affairs, the Ministry of Justice, the Department for Work and Pensions and the Home Office were found to have incorrectly applied the off-payroll legislation.  

HMRC claims that they offered extensive guidance and support to public bodies in preparation for the changes, something you wouldn’t be able to guess by looking at the extent of non-compliance. 

So, what went wrong?

Firstly, it should be mentioned that the public sector had little time to get to grips with the legislation and all corresponding guidance. The definitive confirmation that the change in legislation was happening came in November 2016, by April 2017 the rules were due to come into play, though the ‘complete’ version of HMRC’s CEST was not available until March 2017. At this speed, it’s no wonder public sector employees responsible for implementing changes within their organisations made some mistakes. 

Secondly, a common denominator across the board is the use of CEST. DEFRA, for example (found to be non-compliant between April 2017 and March 2022) had relied on CEST to determine IR35 status of their contractors. They received a tax bill totalling £86.5 million. 

The Venn diagram of the government bodies who relied on CEST and the government bodies who were fined for IR35 non-compliance is as close to a circle as you can get. Tax advisors and professionals have long been questioning the accuracy and reliability of the tool, not only for its complete dismissal of mutuality of obligations, but also for the its deficient substitution questions. 

The report published by the National Audit Office in 2022 echoed these concerns over the tool and how it does not always provide a conclusive result. It called for improvements, and to give some credit, HMRC improved their CEST guidance and provided webinars before the private sector rollout. 

To summarise the key lessons from the implementation of off payroll in the public sector:

Understanding IR35

Every entity in the chain must be aware of IR35. The person/department in charge of IR35 determinations must be comfortable with the legislation and how it works in real terms.

As well as this, fee payers and decision makers need to be aware of what taking ‘reasonable care’ looks like. You don’t want to find yourself being labelled “careless”, just like The Home Office! Merely using CEST without taking into account the contractual terms or taking the time to understand the legislation is not likely to be sufficient ‘reasonable care’. 

Understanding contractual chains and obligations on parties

Both decision makers and fee payers must be aware of their respective obligations under Chapter 10 ITEPA 2003. 

In a 2022 Public Accounts Committee probe into how governmental bodies missed the target by a mile, HMRC conceded that they recognised the “key personnel in those departments” did not understand “the contractual framework that they were operating in”. 

The person in charge of decision making must be aware of how their company engages contractors and what they actually do in practice, i.e. someone in HR who has no day-to-day contact with the workers may not answer the questions about their working practices in the most accurate way. This job would be best fulfilled by someone who has regular contact with the worker.

In the same vein, it needs to be understood throughout the organisation that PSC contractors are self-employed – and have to be treated that way.    

Taking caution when relying solely on CEST/ HMRC guidance

Where professional advice is not an option, we strongly recommend reading the guidance that comes with CEST (ESM11005 onwards). Where you rely on HMRC guidance, make sure you keep a copy of the guidance and stay up to date with any changes, as HMRC guidance is subject to frequent revisions.  

It is important to remember that HMRC guidance is not the law, but HMRC’s interpretation of the law, which given the number of historical tribunal and court cases that they have lost relating to IR35, would suggest HMRC’s view is not always correct.

Finally, CEST output is only as accurate as the input, and HMRC will not stand by any result where false/inaccurate information has been provided. Again, the person in charge of using the tool has to have good working knowledge of how the contractors operate within their organisation. 

Though HMRC has already addressed some of the concerns from the NAO report, such as the strengthening of the disagreement process (which was found to be lacking in the 2017 reforms) the legislation is still far from working perfectly. 

We always recommend that an established professional advisor – one with experience in dealing with HMRC and a track record of success – is engaged to double check contracts and working practices. It may seem less attractive than the free CEST option, though free in the short term is not always free in the long run.