Defra confirms final settlement of £86.5m with HMRC over ‘historic’ IR35 status assessment errors

The Department for Environment, Food and Rural Affairs (Defra) has handed over a further £23m in unpaid tax to HM Revenue & Customs (HMRC) for IR35-related compliance errors – sending its final settlement figure soaring to £86.5m.

The department’s IR35 compliance procedures have been the subject of a recently concluded and long-running inquiry by HMRC, which began in 2019.

Details of the inquiry came to light in Defra’s 2019-2020 Annual Report and Accounts (ARA) document on its publication in December 2020, which confirmed that HMRC was investigating the department for incorrectly assessing the IR35 status of a number of its contractors.

As confirmed in the report, the department had used HMRC’s own online Check Employment Status for Tax (CEST) tool and its accompanying guidance to determine the IR35 status of its contractors, but “historic inaccuracies” were picked up during “internal checks”, triggering an inquiry.

“We have reassessed the IR35 status of current contractors under the revised guidance and used the results to estimate a potential liability for additional tax the department may incur as and when the compliance audit work underway with HM Revenue & Customs is concluded,” said the report.

It also confirmed that, as a result of these reassessments, the percentage of “current” contractors working for the department on an inside-IR35 basis had risen from 5% to 29%. “This revised percentage has been applied over the remainder of the population of contractors who are no longer with the department to obtain an estimated tax liability for this population,” it said. 

Defra published its 2021-2022 ARA in late October 2022, which said the organisation had an outstanding liability of £63.2m at that point, but the total amount it owed HMRC was still to be worked out.

In response to a Freedom of Information (FOI) request asking for details about how much unpaid tax it ended up having to pay out in total for its IR35 status assessment errors, Defra has confirmed that its final liability is £86.5m, including £4m in interest, which has now been paid to HMRC.  

This figure is understood to be based on liability calculations carried out by HMRC that cover the period from 6 April 2017 to 31 March 2022.

For context, 6 April 2017 was the date when public sector organisations assumed responsibility for determining whether the contractors they engage with should be taxed in the same way as permanent, salaried employees (inside IR35) or off-payroll workers (outside IR35), based on the work they do and how it is performed. Before then, it was up to the contractors themselves to declare whether or not their engagements were inside IR35.

An inside-IR35 determination means contractors are expected to pay the same income tax and national insurance contributions as a permanent employee, but are not entitled to receive the same workplace benefits that a salaried worker would.

Computer Weekly contacted Defra for comment on this story, and it confirmed the content of the FOI request and restated that the final liability figure for the department stands at £86.5m.

This puts the scale of the department’s IR35 assessment errors on a par with those recorded by the Department for Work and Pensions (DWP), which ended up paying HMRC £87.9m in unpaid tax after making a series of “historic” mistakes of its own.  

Dave Chaplin, CEO of tax compliance firm IR35 Shield, said the fact that Defra relied on HMRC’s own tools and guidance to carry out its initial assessments, only to be hit with a sizeable tax bill as a result, is “somewhat embarrassing” for all concerned.

“It serves to highlight the complexity of the off-payroll legislation and that HMRC’s own guidelines are not reliable,” Chaplin told Computer Weekly.

It also serves as a reminder of just how complex the IR35 legislation is and how urgently it needs an overhaul, he added.

“The chancellor u-turned on his predecessor’s plans to repeal off-payroll, which was an unwise move,” said Chaplin. “Off-payroll desperately needs to be fixed or ditched.”

He said it is also worth noting that any contractors who were engaged on an outside-IR35 basis by Defra and have since been reclassified as working inside IR35 are entitled to reclaim any tax they have previously paid.

“Any contractors who were engaged by Defra on an ‘outside IR35’ basis and have since been ruled as ‘inside IR35’ by HMRC can now claim back all of their tax, and pay none,” he added. “And Defra is not alone. There is potentially around £250m worth of tax reclaims out there. When HMRC enforce their own rules in the public sector, they lose money.”