IR35: Thousands of contractors have been wrongly taxed

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New information indicates that public sector bodies are ignoring the results of the HMRC tool (CEST), and may have deducted incorrect amounts of tax and NI from contractors. 

It has been over a year since the off-payroll working (IR35) rules were introduced for public sector contracts, and there are still enormous problems with the implementation of these rules.

In contrast to IR35 for private sector contracts, where the contractor decides whether their contract is within IR35, the public sector body (PSB), the ultimate customer for the contractor, must decide whether the contractor should be subject to the IR35 rules for that particular contract.

If the worker does fall within IR35, the fee-paying organisation in the chain (usually the employment agency) is responsible for deducting and paying over PAYE from payments made to the worker’s personal service company (PSC).

Some PSBs have also deducted employers’ secondary class 1 NI from the contractors’ invoices which is incorrect (under Social Security Contributions (Intermediaries) regulations (SI 2000/727)).

How to decide?

HMRC advises public sector bodies to use the check employment status for tax (CEST) tool to reach a conclusion on the IR35 status of the worker.

HMRC said it will stand by the results of the CEST test, as long as accurate information was used to provide answers to the questions the tool poses. However, the PSB is not obliged to follow the results of the CEST test.

Is CEST used?

A freedom of information (FOI) request submitted by ContractorCalculator revealed that the CEST tool was used 576,490 times between March and October 2017. This was the peak demand for the tool as the revised IR35 rules for the public sector came into effect on 6 April 2017.

In later months, the CEST tool has been used roughly 40,000 times per month. This high activity level indicates that the CEST is being used by PSBs, but are they paying attention to the results?     

CEST results

The same FOI request also uncovered statistics for the results of the CEST tool: 31% of contracts tested resulted in “within IR35”, 54% of the contracts were found to be outside IR35, and in 15% of cases the CEST tool could not provide a definite answer.

Dave Chaplin, CEO and founder of ContractorCalculator, believes the CEST results are in line with his experience that roughly 30% of contracts used by IT contractors fall squarely with IR35.

HMRC has also always claimed that the CEST tool will provide an answer in 85% of cases, so the tool appears to be performing in line with expectations.

“Despite CEST’s advice, many hirers have been taxing contractors as employees,” said Chaplin. “We know that blanket assessments have been imposed within the NHS and the Ministry of Defence (MoD), as well as on other key public sector projects.”

Chaplin said the logical conclusion is that the PSBs are using the CEST tool, but they are ignoring the results in many cases. 

Why is CEST result ignored?

The shortcomings of the CEST tool are well known. Mark Taylor of Chartergates Legal Services test-drove the tool in March 2017 and found that it appears to ignore the core principle of mutuality of obligation, and thus would struggle to determine borderline cases. This conclusion is supported by analysis of the inner workings of the tool undertaken by ContractorCalculator.  

“We have published evidence proving CEST provides incorrect answers and is not fit for purpose,” commented Chaplin. “This creates a risk for hirers and agencies. Receiving a pass from CEST is the equivalent to being presented with a dodgy MOT certificate. In light of this, it isn’t too surprising that so many hirers have taken the supposedly risk-averse option. They simply do not trust CEST’s results.”

What can contractors do?

As Bhavina Carsane of Chartergates concluded in July 2017, there is no route for a contractor to appeal a ruling on an IR35 decision made by its PSB client.

The fee-payer, or the party which has the direct contract with the PSB, can ask the PSB for written details of its reasoning concerning the IR35 status decision, but the contractor does not have that right.

However, Chaplin believes that some contractors could mount a legal challenge in the County Courts against their agency for misrepresentation, or alternative challenge their treatment at an employment tribunal.

About Rebecca Cave

Consulting tax editor for Accountingweb.co.uk. I also co-author several annual tax books for Bloomsbury Professional and write newsletters for other publishers.

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By NeilW
30th Apr 2018 10:08

Ultimately if you are in the 'talent' economy you drive up your rate to compensate.

It would be far better if this was fixed on the employment side, and that the hirer gets an employee if they hire an employee in an employee like fashion. No amount of intermediaries should allow businesses to evade their legal responsibilities.

The taxation then follows from that.

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30th Apr 2018 10:13

If the thrust of the article is correct, then I suspect HMRC see this as a "win" in their campaign against contractors.

Tax is collected and if there is no easy and simple way to appeal and correct the tax position, happy days for the agency.

Given that the "success" of this reform is already being toasted ahead of any independent measure, we will see the extension into the private sector soon. It is to be hoped that all of those in the chain of entities who benefit from the contractor's skill, will at least step up to their share of the additional costs.

Unfortunately that would be contrary to the history in this area where the person with the skills is usually also the target of HMRC action.

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By NH
30th Apr 2018 10:20

The deduction of the Employers NI is a really annoying one for my clients, argued until I was blue in the face with the agency and the agency accountants but they wouldn't have it, even when I pointed out the HMRC guidance (believe or not one of my clients was working for HMRC as well!)

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to NH
30th Apr 2018 10:29

NH wrote:

The deduction of the Employers NI is a really annoying one for my clients, argued until I was blue in the face with the agency and the agency accountants but they wouldn't have it, even when I pointed out the HMRC guidance (believe or not one of my clients was working for HMRC as well!)

Yes very annoying. I know a few people who have been treated as "umbrella" employees, i.e. getting part paid as expenses to avoid the tax but having Employers NI deducted from them. I could name the paying agency involved but...hmm maybe not

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By cfield
30th Apr 2018 17:07

Presumably it is impossible to detect who was actually using the CEST as it is meant to be an anonymous tool. My guess is that most of the people who've been using it are contractors or their advisors, curious to know if they should have been given a pass, not the client managers or the agencies. The latter are all busy people and simply don't have the time to assess people on it, nor indeed the inclination, as there is nothing to stop them imposing these blanket policies.

I don't get the comparison to a dodgy MOT though. For one thing, paper MOT certificates are a thing of the past (it's all done online now) but that aside, HMRC promised to stand by the CEST results if the answers given were correct. The results are not invalidated just because the CEST isn't fit for purpose. It is certainly not illegal like the dodgy MOTs used to be.

Moreover, that is not the reason the public sector bodies are ignoring it. They are ignoring it because it's too much time and trouble to assess people individually. In fact, if the CEST was fit for purpose, they would be even less inclined to use it, as it would inevitably require them to answer loads more questions.

The CEST is much maligned but are we not are looking a gift horse in the mouth here? After all, it does rule in your favour if you can honestly answer the control and substitution questions the right way. If anything it errs in favour of the contractor.

I know it doesn't mention MOO, but I don't think all that many contracts are free of MOO anyway, so it's a bit of a MOOt point really (couldn't resist that one).

Thanks (3)
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to cfield
30th Apr 2018 11:09

Perhaps the issue here is that PSB don't have the expertise in tax law or the knowledge of the duties being undertaken to actually complete the CEST questions? Herein lies a key flaw.

Another is that projects using technology will morph and change over their life and it would be unusual for the original brief to be conducted exactly as described. Here is another flaw as HMRC has said that they will stand by the results "if the answers are correct". We're now a month after the first year end of this tool and I predict that in 6 months, we will see the first HMRC letters contesting the results.

This will be because either too many are coming back as genuinely self employed and/or because of the above variation of actual work to planned work.

Given the policy of HMRC over the past 15+ years towards contractors, which has burnt all trust between them, a lot of our clients see absolutely no point in using the CEST tool and many have left PSBs even where they have no private sector job to go to.

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