Reading between the lines of HMRC’s IR35 impact report

To better understand the impact of the off-payroll working rules, known as IR35, HMRC recently produced a report on the short-term effects of the IR35 reform on the private and voluntary sectors. The report is fairly positive and if you took the report at face value – you would believe the roll out of the new legislation was a success.

The changes to IR35 were introduced to the private sector in April 2021, transferring the responsibility for determining contractor employment status to the hirer.

The past two years has seen the legislation slowly become embedded across the flexible workforce, with energy businesses and hirers now looking toward best practice to ensure compliance. But to get a real picture of the impact – and potential compliance risks – you need to read between the lines of the report.

The full picture of IR35’s short term impact HMRC’s recent report explores the impact of the legislation but only presents a partial rose-tinted picture. To get a true understanding of its impact to date and how it could affect businesses in the future, you need to delve beyond the surface.

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For those that pay attention, the report does signpost a real concern – that a third of businesses working with contractors have spent little or nothing on ongoing costs to comply with the rules. With the legislation widely recognised as complex, this could mean that the third of end clients who continue to engage with PSCs without incurring compliance costs may have misunderstood the ongoing requirements of the legislation and may believe they are compliant, when in fact they are not.

Added to this, more than half of organisations said all of their contractors fell entirely outside or inside the rules, but based on Brookson Legal’s IR35 reviews to date, this is very rarely – if ever – the case.

Incorrect categorisation

These responses suggest that a significant proportion of the 130,000 individuals who have been moved to payroll as a result of the new IR35 rules may have had contracts incorrectly categorised as inside IR35 and are now paying unnecessary employment taxes.

HMRC was keen to highlight that this represents just 2.5% of the total self-employed workforce and less than 1% of the total workforce. This may seem like an acceptable percentage to HMRC, but it signals a failure in correctly categorising contractors which has a knock-on impact on affected contractors and should not be considered tolerable.

A spotlight on compliance issues

Compliance issues are the other major concern. With HMRC now conducting enforcement activity, many hiring businesses could be at real risk of unexpected tax bills and fines further down the line.

The responses suggest a false sense of confidence in automated tools such as CEST. The tool was used by a majority of organisations despite being repeatedly demonstrated not to deliver sufficient ‘reasonable care’ in a series of high-profile public sector tax repayments made in 2022.

The risk of compliance mistakes and not meeting the ‘reasonable care threshold’ set out in HMRC’s own off-payroll guidance can result in significant hidden tax liabilities and potential fines.

Although only around 10% of end clients represent around a half of the total “compliance spend”, there seems to be no analysis in the report surrounding compliance levels across businesses. This feels like a major oversight and an area of hidden risk and liability.

But what does the report mean for the future of IR35 and access to contractor talent?

Access to the flexible workforce

The flexible workforce is crucial for supporting the oil and gas sector navigate challenges and support growth, and compliance with the off-payroll working rules is an essential to accessing contractor talent.

This is particularly true following the events of the last 12 months which saw economic turbulence – with the energy crisis, legislative U-turns and windfall taxes now meaning that several North Sea investments are currently under review.

Amidst uncertainty and projects pending the final go ahead, businesses need to ensure they are compliant with IR35 by seeking expert guidance and advice. This will ensure they can continue to access the flexible workforce, scaling up and down their workforce as needed to successfully navigate 2023.

With several reports including a House of Lords review and reports from the House of Commons Public Accounts Committee and the National Audit Office, and now the report from HMRC, it’s clear the Government needs to listen to its advisers and take action to help simplify IR35 for the benefit of the flexible workforce and the broader economy.