The UK tax authority is facing “new and challenging risks” policing changes to the rules governing payment of contractors in the private sector, according to a report by the independent public spending watchdog.
Changes to the rules, known as IR35, were brought into the private sector in April 2021, following a rollout to the public sector in 2017. They shifted responsibility for assessing the employment tax status of freelance workers from the individual to the organization hiring them.
The measure was introduced to tackle tax avoidance from so-called “disguised employees”. This is when workers – who bill for their services via limited companies – avoid paying income tax and national insurance contributions, despite effectively being employees. Instead they pay corporate taxes, which are typically lower.
The National Audit Office concluded that while public sector reforms in 2017 had succeeded in reducing avoidance and increasing tax revenue, the rollout had been rushed. Nearly half of public sector organizations surveyed by HM Revenue & Customs said they found the reforms difficult to comply with, it reported.
Meanwhile, the agency warned that HMRC faced further challenges to “identify, monitor and address non-compliance” in the much larger private sector, which has more complex labor supply chains.
This created greater risk for HMRC’s supervision, of companies making mistakes and of reforms resulting in workers changing careers, or business moving overseas, the report cautioned. HMRC was also more likely to face future legal challenges from companies, unlike public bodies, it said.
Gareth Davies, head of the NAO, said: “While key lessons were applied during the wider rollout in 2021, the inherent differences in labor markets create new challenges that HMRC will need to manage for reforms to be a success.”
HMRC originally estimated that around 30,000 people using personal service companies in the public sector would be affected by the changes, compared to around 180,000 people in the private sector.
The NAO reported on Thursday that HMRC estimated two years after the public sector changes that an additional 50,000 people were on the payroll in public bodies, resulting in a net increase in tax of £ 250mn over the period – £ 100mn HMRC had anticipated.
However, it also reported that public bodies had found it harder and more expensive to hire contractors – although it noted it was unclear if this was solely down to the reforms.
The NAO warned that HMRC may have underestimated the costs to organizations of implementing the changes and urged it to update its estimates based on real-world experience. It said further changes were needed to improve the online tool developed by HMRC to help hirers check the status of workers.
Responding to the report, Meg Hillier, chair of the House of Commons public accounts committee, criticized HMRC for a “haphazard rollout of stage one of the new IR35 guidance”. This had left public bodies “confused by the changes” and had contributed to “high levels of non-compliance by government departments”, she said.
The report found government departments and agencies included additional tax liabilities of £ 263mn, from failing to administer the reforms correctly, in their 2020-21 financial statements. The three largest losses were incurred by the Department for Work & Pensions (£ 87.9mn), the Ministry of Justice (£ 72mn) and the Home Office (£ 29.5mn).
Hillier urged HMRC to “learn its lessons and tread carefully” in the private sector to avoid knock-on negative effects in the labor market and the wider economy.
HMRC said it “continued to adapt our approach to improve compliance with the rules in the public sector, support organizations to get things right, and enable a successful extension of the rules to the private and voluntary sectors”.