IR35: how HMRC responded to criticism from the House of Lords

The House of Lords set clear recommendations for fixing IR35 in February, but the government’s recent response suggests that it won’t be putting them in place.

• What is an umbrella company?
• What happens if I’m inside IR35?
• The self-employed guide to Self Assessment tax returns
• What does professional indemnity insurance cover?

For up-to-date IR35 news, here’s HMRC’s response to the six recommendations for IR35 we wrote about in February.

HMRC responds to: blanket assessments

The House of Lords said that HMRC should take a stricter approach towards blanket assessments (when businesses make status determinations without looking at individual contracts).

Blanket assessments are non-compliant, so the House of Lords wants to see a better process put in place for appeals. In its response, HMRC says compliance activity includes:

• checking a client’s decision-making process for status determinations (by looking at a sample of both inside and outside decisions)
• correcting bad decisions and educating businesses on how to improve making those decisions
• asking businesses for information on how they resolve disputes, which also shows whether they’re taking reasonable care when making decisions

Contractors, does this ring true for you?

HMRC’s response only addresses what they’re doing when they’re making checks, with no suggestion as to how they could take a more active approach to non-compliance.

What’s more, HMRC says its independent research shows that the use of blanket determinations is “extremely rare”. Is that your experience?

HMRC responds to: problems with its IR35 tool

The House of Lords wanted to see HMRC clarify that its Check Employment Status for Tax (CEST) tool isn’t a “substitute for law”. It also wanted HMRC to make modifications to CEST to include questions on mutuality of obligation (MOO), an important part of case law that tests whether a contractor is obligated to be given (and to accept) work.

HMRC points to CEST’s “ease of use” and the fact that it gives a clear status determination in 80 per cent of cases. But that leaves a significant 20 per cent of unclear determinations. So, HMRC will review the current signposting to ensure that users are better directed to further support.

HMRC also reiterates that it’s not compulsory to use CEST.

But HMRC ignores the Lords’ concerns about MOO. CEST assumes that because a contract is in place, MOO already exists, though many contractors and experts think this is misguided. Indeed, witnesses told the House of Lords that “CEST was flawed unless mutuality was addressed”.

The most important part of HMRC’s response is that it reiterates that regardless of whether CEST is used or not, HMRC will always consider actual working practices in its compliance checks.

This means you should always be monitoring whether the way you work actually aligns with your contract.

HMRC responds to: IR35’s economic impact

The House of Lords highlighted concerns that 2021’s IR35 changes have introduced labour market challenges, as they've made the sector less flexible.

But HMRC says it sees no compelling evidence this is down to IR35 changes, especially against the backdrop of global supply chain challenges brought on by Covid-19.

HMRC agrees with the House of Lords that external research into the impact of 2021’s changes should be carried out “expeditiously”. The tax body points to the fact that initial fieldwork is already happening with businesses that hire contractors.

That being said, HMRC thinks it’s too late to broaden the scope of this research to include the wider impact of IR35 on the economy.

HMRC also says that if a business chooses not to hire contractors as a rule, it’s a “legitimate business decision”. But this doesn’t address the fact the approach is very risk-averse and not flexible for the economy.

HMRC responds to: the burden of IR35 costs

Following the Lords’ suggestion that HMRC has failed to appreciate the ongoing administrative costs for compliant businesses, HMRC has reiterated that it anticipates a “small net saving per year”, despite recognising the burden as “significant but varied”.

Its ongoing research will continue to look at the “actual amounts” being spent on complying with the rules by clients.

HMRC seems like it doesn't want to explore the suggestion that some organisations are passing on the cost of paying National Insurance contributions to contractors with little bargaining power. HMRC says it’s “standard for employers to set wages with regard to the overall tax bill” and that wages are also affected by other factors.

HMRC responds to: regulating umbrella companies

While the House of Lords felt that HMRC is being slow to act regarding rogue umbrella companies, the tax body’s letter does little to reassure contractors that regulating umbrella companies is a priority.

HMRC says that the enforcement body for regulation will still be created, but legislation will only be brought forward “when parliamentary time allows”.

HMRC points to its education efforts elsewhere, for example a tax avoidance explainer campaign that helps contractors avoid non-compliant schemes.

HMRC responds to: wider employment status

HMRC notes that the relationship between tax status and employment rights is “complex and important”, but still reiterates that they’re “separate frameworks”.

The government is looking at how best to address the issue. That being said, more information will only be published “in due course” – reflecting HMRC’s similar stance on regulating umbrella companies.

Read HMRC’s response in full.