Tax changes raised £250m, but heaped cost on employers, review finds

A Government plan to stop employees pretending they are private contractors to avoid National Insurance has raised more money than first thought, but has been costly for employers.

The National Audit Office found that HM Revenue and Customs might have “underestimated” the cost of the new reforms to public sector employers.

It had tried to update rules to make it more difficult for outside contractors to claim they were not on payroll. A 2017 change meant that public sector employers had responsibility for ensuring their contractors were not so-called “disguised employees”.

It was a problem that HMRC estimates cost the public purse around £440 million in a year.

But it has led to extra costs and challenges in recruiting contractors, or keeping them on the books.

“Public bodies we interviewed explained that they had dedicated a lot of ongoing resource to employment status determinations, such as full-time staff, supporting teams and review panels,” the NAO said.

“Some public bodies have also reported difficulties in finding contractors, and that fee rates have risen.”

It is difficult to determine how much of this is due to the reforms to the IR35 rules, and how much is due to Brexit or Covid, the NAO said.

However, it said: “HMRC may have underestimated the cost to employers of implementing the reforms.”

Meg Hillier, chair of the Committee of Public Accounts, said: “HMRC’s haphazard roll-out of stage one of the new IR35 guidance meant public bodies were confused by the changes and had no time to prepare.

“This contributed to high levels of non-compliance by Government departments. It’s a potentially rocky road ahead as HMRC wheels out the changes for the private sector, which is far larger and more complex.

“Some businesses may get jittery if the new requirements aren’t clear, leading to knock-on effects for the labour market and the economy.

“HMRC must learn its lessons and tread carefully if it’s not to scare the horses.”

HMRC said: “We welcome the report’s recognition that the reforms succeeded in making things fairer, with increased compliance with the off-payroll rules.

“More people working like employees have paid tax like employees, levelling the playing field.

“We have continued to adapt our approach to improve compliance with the rules in the public sector, support organisations to get things right, and enable a successful extension of the rules to the private and voluntary sectors.”

The reforms did help. HMRC said that the number of workers that were considered employed for tax purposes rose by around 50,000 in total.

It drove a net increase in tax revenue of £250 million, more than the £150 million that officials had expected.

“It is difficult to identify the exact extent to which this is due to the reform itself, as opposed to other factors,” the NAO said.

The rules had been heavily abused before being updated. According to one estimate from HMRC, only one in ten personal service companies were applying the rules correctly.

Previous changes in 2007 and 2015 had not done much to help.

The rules were extended to private businesses in April last year and have been in place since April 2017 for public bodies.

But the HMRC botched parts of the 2017 roll-out, the NAO found in its report released on Thursday.

It took officials until only two months before the new rules came into effect to publish their guidance. And a key online tool for determining tax status was launched with only one month to go.

In 2018 an HMRC survey showed that around half of public bodies did not think they had enough time to prepare.

There had also been some problems with the tool and with the official guidance, which HMRC tried to fix in 2019.