IR35: NAO says HMRC is over-collecting tax from the public sector

The tax agency has failed to tell contractors they may be eligible for a refund

The HMRC is under fire after a damning report from the National Audit Office (NAO) found that the agency is collecting more tax than it is due.

According to the report, HMRC has not been informing contractors that they could be entitled to reclaim the tax they've paid, if the public sector entity they work for has been billed for failing to properly implement the new IR35 laws.

The changes to the off-payroll working rules, commonly known as IR35, were rolled out to the public sector in 2017, and the private sector in April 2021. The change made medium and large-sized private and public sector organisations responsible for determining the employment status of the contractors they engage, for tax purposes.

In other words, organisations now have to decide whether the contractors they use should be taxed as off-payroll workers or permanent employees.

Under previous IR35 rules, which were in place for nearly 20 years, contractors were allowed to self-declare their tax liabilities; that is, whether they should be taxed in the same way as salaried workers or as off-payroll employees. That system was open to abuse, HMRC believed, because contractors could intentionally mis-classify their working arrangements with their employers to curtail their tax liabilities.

The NAO has now released the findings of its investigation into how HMRC managed the rollout of IR35 reforms in the public sector.

The inquiry covered the risks of reform implementation, the public sector's compliance, lessons learned and recommendations for HMRC to improve.

The report concluded that while the reforms have successfully lowered evasion and raised tax income, the rollout had been hurried. Nearly half of public sector organisations surveyed by HMRC said they had found the reforms difficult to comply with.

As per the NAO report, non-compliant government departments and agencies have paid HMRC a total of £263 million to date.

However, the NAO also said that when determining how much tax non-compliant public sector groups owe, HMRC failed to account for the corporation tax or VAT that contractors would have previously paid.

The report says HMRC 'collects the amount due in accordance with the law at that time' and 'does not offset the total amount against any tax the work or their [personal service company] already paid'.

HMRC said 'this was not allowed within the current legislation,' meaning the agency 'collects more tax in total than is due'.

Once a non-compliant public sector entity acknowledges errors in its IR35 status decisions, the contractor can claim a tax refund, but HMRC does not publicly advertise this right.

'It is unclear how many workers reclaim their taxes in practice,' the NAO added.

Am HMRC spokesperson told Computer Weekly that the assertion that HMRC over-collects tax was incorrect.

"HMRC can only collect what is due in law and, as such, HMRC collects the correct amount of tax due under the legislation at the time it is collected," the statement said.

"However, where an error is later discovered, the result is that amounts that were paid correctly at the time are no longer due, as the income should have been subject to PAYE instead," it added.