Public sector projects are under threat as more clients, agencies and providers lose trust in HMRC’s flawed Employment Status Service (ESS) tool.
- The ESS has been proven to give erratic results that don’t align with case law
- Using the ESS could present serious tax liability risks for clients and/or agencies
- The uncertainty means clients are attempting to push contractors into umbrellas
As a result, contractors are leaving the public sector in their droves, leaving projects in limbo.
The IR35 reforms are just two weeks away, but their enforcement desperately needs to be delayed for at least six months to allow clients to find alternate IR35 testing methods and to stop projects being harmed. The ESS is not fit for purpose, clients and agencies are unprepared, and the public sector as a whole is in disarray.
HMRC’s ESS tool – the risk to clients and agencies
The tool’s flaws aren’t the only reasons clients and agencies are losing trust. After insisting that it would be bound by the ESS tool results throughout consultation phase, HMRC has backtracked.
HMRC now says it won’t stand by the findings achieved through ‘contrived arrangements’, or where it believes the client or agent answered questions incorrectly.
Clients manage how they hire people in a particular manner to prevent them from claiming employment rights. This isn’t contrived. It’s simply part of running a business.
But given that HMRC claims non-compliance in the public sector is at 90%, it will come as no surprise if it begins to challenge any findings it disagrees with. And like IR35 as a whole, many of the questions asked by the ESS are subjective, giving HMRC further leeway to break its promise, leaving agencies to pick up any resulting tax bill.
The proof that you can’t rely on the ESS tool
Recently we put the ESS to the test against the 21 historical IR35 tribunal cases, and found its outcomes to be both unreliable and erratic.
We’ve since been comparing the results that contractors have received when using the ESS with the results they received when using our tool, and the trends we’re seeing so far are strikingly similar:
- HMRC appears to be giving 25% of contractors an ‘Unknown’ result
- The majority of these ‘Unknowns’ should be clear passes
- 30% appear to be receiving passes from the ESS when they should fail IR35
IR35 is subjective and status needs to be presented on a spectrum, so having an ‘Unknown’ answer is definitely justified for the borderline cases, and I made the case personally to the Treasury that without an 'Unknown' category the tool would lack credibility. However, the problem we are seeing is that the HMRC ‘Unknowns’ appear to be scattered all across the spectrum rather than gathered around the borderline between pass and fail.
The findings reinforce what myself and other reputable commentators have been saying for months – you simply can’t rely on it. HMRC has inadvertently conceded that the ESS isn’t ready by admitting that it is still developing the tool. But if it isn’t ready, why is it out?
And before our contractor readers attempt to lynch me for stating that the ESS is passing contractors who should fail, I should highlight that has already been well known by providers for many weeks in the market, despite HMRC’s denial of the issues.
Why HMRC is years away from building an accurate IR35 tool
Many of the issues boil down to the fact that HMRC rushed its tool. We have proven that it is possible for an automated system to accurately evaluate IR35 status. The difference is we have spent seven years developing ours – HMRC gave itself less than one.
This isn’t enough time to put the IR35 jigsaw together. Accurate assessment of IR35 needs to look at the whole picture. The taxman is still missing an awful lot of pieces.
After taking a look under the bonnet of HMRC’s tool, it’s evident that the underlying code and structure don’t seem right. The fundamental issues are:
- The weightings granted to questions are divorced from case law
- Some questions have no basis in case law
- Other questions mislead the reader altogether
- There are key elements of case law simply missing
Tinkering with what HMRC currently has isn’t going to help. The taxman effectively needs to start from scratch. It will take well over a year, and near two, for HMRC to build something usable; five years if the Government’s own Employment Status Review is to be believed.
HMRC’s IR35 tool – not a checklist approach, but still not good enough
Recently, legal challenges have been made against the reforms on the basis of HMRC’s tool, comparing the ESS to the ‘checklist approach’ to determining employment status dismissed by the judge in the Hall v Lorimer [1993] case.
It is correct to claim that a checklist that simply tallies up the ticks and crosses can’t do the job. But a comprehensive series of well-crafted questions and an algorithm capable of using the information gained to form the same picture a judge would form can, and does work.
HMRC is building an AI system designed achieve this. AI systems have been used for decades in the medical profession, and have even been proven more accurate than experts on occasion.
Our IR35 testing tool is further testament to the accuracy of AI systems – it mirrored the judge’s evaluation in every case when tested against the 21 IR35 tribunal outcomes. Unfortunately, despite a valiant attempt, HMRC has fallen short of building an AI system that is fit for purpose.
IR35 uncertainty – the impact on public sector projects
The fallout from all of this is huge. The uncertainty is plaguing public sector projects already. Organisations are attempting to impose blanket rules forcing contractors into umbrella models to eliminate perceived tax risk, and contractors are walking away as a result - they refuse to be subject to 'false employment'.
It’s total chaos and it’s all on HMRC’s hands. The ESS arrived late and can’t do the job it’s intended to do. As a result clients and agencies are severely unprepared. The reforms need to be postponed for six months to allow the public sector to get ready and identify alternative compliance solutions.
We don’t need further deterrents from our contractors remaining in the public sector. With Brexit looming, we need as many of our best digital contractors on board as possible. At the moment, they’re leaving in their droves.