Government departments pay the price of using CEST to determine IR35 status
After Defra and the MoJ published details of IR35 bills that together amount to over £120m, the tax demanded by HMRC to government departments since IR35 reform in the public sector was rolled out in 2017 now stands at £244m.
Defra revealed in its 2020/21 Annual Report and Accounts that it had a £48m tax liability, resulting from making incorrect IR35 status determinations. The MoJ meanwhile, gave details of its £72.1m bill.
These staggering sums follow on from the DwP (£87.9m), the Home Office (£33m), HM Courts & Tribunal Service (£12.5m) and NHS Digital (£4.3m), each of which have been hit with tax payments resulting from non-compliance.
Departments’ reliance on CEST proves costly
Like many before them, both Defra and the MoJ relied on HMRC’s Check Employment Status for Tax (CEST) tool, along with other available guidance from the tax office, to determine the IR35 status of contractors.
In other words, this is not the first time that HMRC’s own technology has contributed to mistakes and subsequently, non-compliance – nor is it likely to be the last.
As proven in both of these instances, the tax office will not necessarily stand by a result provided by CEST, which is not fully aligned with IR35 case law, fails to provide an answer in approximately 20% of cases and is largely distrusted by contractors.
For more on why businesses are advised against using CEST, please click here.
Defra’s £48m IR35 bill not set in stone and could rise
The worry for Defra is that the £48m figure could amount to even more, as the accounts report states:
“HMRC launched an enquiry into Defra’s compliance with the off-payroll working (IR35) rules in relation to contingent labour in 2019. The enquiry is on-going, but it has determined there have been instances where contractors were incorrectly assessed as out of scope.”
As a result, the department explained that it reassessed its contractors, with those working outside falling from 85% to just 22%.
Even so, and as Defra made clear, the investigation is “still ongoing”, which means the £48m sum is only a provisional tax liability and possible interest or penalties may still yet be issued.
MoJ faces £15m penalty in addition to £72.1m tax liability
In contrast, the MoJ has a better – albeit not definitive – idea of where it stands. The £72.1m bill issued by HMRC includes a £4.5m interest charge, relating to the three year period (2017-2020) in which the department had made mistakes.
However, the final amount could rise – by £15m – after HMRC found that the department had been “careless” in its application of IR35. At the time of writing, the penalty had been suspended for 3 months “subject to certain conditions”, which is why MoJ hadn’t included it in its total losses.
A point worth making is that this possible penalty isn’t related to engaging contractors under the wrong IR35 status. The MoJ failed to meet its legal obligations under IR35 reform, which includes “notification and filing obligations, a 100% assurance check on all out of scope determinations, and improved training of hiring managers.”
This could relate to a number of oversights, including issuing Status Determination Statements (SDS) to contractors and ensuring compliance throughout the labour supply chain.
What does this mean for businesses?
HMRC’s aggressive policing of IR35 compliance, even among government departments, emphasises the importance of not only carrying out rigorous IR35 determinations, but also ensuring and maintaining compliance overall.
What’s more, the MoJ’s £15m penalty and the possibility of Defra also receiving one, is a timely reminder to private sector businesses that from 6th April 2022, the ‘soft-landing’ will end.
This means HMRC can issue penalties to businesses, in addition to tax liability and interest payments, after a 12-month grace period.