A committee of MPs said HMRC “rushed” implementation of new tax rules (IR35) for off-payroll workers which led to “widespread non-compliance” which is “unacceptable”.

The Public Accounts Committee (PAC) said “government bodies should be best placed to understand the rules” but in 2020/21 “it became clear that many central government departments struggled to comply with the reforms and owed or expected to owe HMRC £263m in back-taxes.

Further, it said that HMRC has “done little to understand” the wider impact of the reforms on workers, the labour market or particular sectors, and it “underestimated the additional costs of implementing the reforms to hiring organisations”.

However, PAC noted that the reforms appear to be bringing in more tax revenue but added that it’s “clear that structural problems remain with the way IR35 operates”.

What is IR35 and what’s the issue?

In 2017, reforms to tax rules for off-payroll working in the public sector were implemented, before it was extended to the private and third sector last year.

These tax rules – IR35 – apply to workers/freelancers/contractors who provide their services through their own limited company or another type of intermediary to a client, but who would otherwise be an ‘employee’ if the intermediary was not used.

As part of the Finance Act 2000, HMRC’s objective was to prevent tax avoidance by these ‘disguised employees’ as estimates suggest it cost the exchequer £440m in lost revenue in 2016/17.

Within the first two years, at least 50,000 people were added to the payroll systems, and the net increase in tax revenue was £250m.

But in the 2020/21 financial statements of government departments and agencies, it included a total of £263m paid, owed or expected to be owed in additional tax for failing to administer the reforms correctly.

In February this year, an investigation by the National Audit Office suggested HMRC faced ‘new risks and cases of non-compliance’ which were likely to fall on employers.

At the time, it stated: “HMRC’s current approach to correcting cases of non-compliance results in it collecting more tax in total than is due, and it does not yet have a plan to address this.”

Tax disputes have also arisen, and the NAO noted that while workers can challenge their tax status with the organisation, “there is not a clear legal route to appeal further”.

This was echoed by PAC’s report today which stated that hiring organisations are unable to properly assess a worker’s status and the appeals process means it’s too difficult for workers to challenge incorrect determinations. Further, it said a “lack of good data and legislative provisions” has seen HMRC taxing the same income twice: “a particular concern in the public sector where government can end up subsidising private sector contractors for all of their tax”.

‘Years of fiddling with these reforms’

Meg Hillier MP, chair of the PAC, said: “While workers in the gig economy have challenged their work and tax status in the courts, there is no recourse for workers deemed subject to IR35 tax rules despite the confusion and non-compliance that persist even in central government itself.

“After years of fiddling with these reforms and with central government spending hundreds of millions of pounds to cover tax for individuals wrongly assessed as self-employed, the fundamental problems underlying UK taxation of work remain. It is now up to HMRC to demonstrate that the system can work fairly in the real world; to prove that it is correctly claiming revenues under the system and that the additional revenues raised are worth the costs and unintended consequences in the labour market.”

An HMRC spokesperson, said: “These reforms have succeeded in making the tax system fairer, with more people who work like employees paying tax like employees, levelling the playing field for everybody else and bringing in the tax that is due under the law.

“We delivered an extensive programme of education and support before the reforms took effect and we have continued to adapt our approach to improve compliance with the rules and support organisations to get things right.

“We welcome the PAC’s acknowledgement that the reforms appear to be bringing in more tax revenue.”