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Off-Payroll (IR35): Flaws in CEST cause £120 million tax bills for MoJ and Defra

Two more Government departments are facing combined additional tax bills of at least £120 million due to incorrectly determining the status of their contractors, despite following HMRC's guidance and using HMRC's Check Employment Status for Tax (CEST) tool. Both are also facing additional penalties for failing to adhere to reasonable care.

Accounts published in December 2021 show that the Ministry of Justice (MoJ) owe £72.1m and that the Department For Environment, Food & Rural Affairs (Defra) owe £48m. These new revelations come after previous Government bodies who used CEST were also hit with substantial tax bills, including the Department for Work and Pensions (£87.9m), the Home Office (£29.5m), and HM Courts and Tribunal Service (£12.5m).

Dave Chaplin, CEO of IR35 Shield, comments on the absurd situation of HMRC now fining the Government bodies they were tasked to educate: "Had this failure occurred in the private sector, the firm providing the advice and guidance would have a claim for negligence on its hands. Instead, having provided the advice, HMRC is now issuing its 'customers' with multi-million-pound tax bills.

"We've consistently warned about the risk of relying on tax advice from HMRC, simply because they are the ones responsible for issuing the tax bills. The DWP, Home Office, HMCTS, Defra and the MoJ are being hit for combined additional taxes of over £250 million and are all victims of the deeply flawed CEST tool. HMRC must now fix or withdraw it before it causes more damage to UK Plc."

HMRC has failed to "stand by" CEST and their guidance

When HMRC launched the Check Employment Status for Tax (CEST) tool in March 2017, the claim on the front page stated: "HMRC will stand by the result given unless a compliance check finds the information provided isn't accurate. "HMRC has since modified this which now reads: "HMRC will stand by all determinations given by the tool, as long as the information you give remains accurate." [Emphasis added]

Defra state in their Annual Report and Accounts 2020-21 that: "We use HM Revenue and Customs' own Check of Employment Status for Tax tool (CEST) and accompanying guidance to make those assessments."

But, the Report also indicates that a change in the HMRC guidance may have triggered the problem, as they refer to themselves using additional HMRC guidance to check historical assessments.

"During 2019–20, internal checks and additional HM Revenue and Customs guidance highlighted inaccuracies in the historical assessment of some contractors' employment status. 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 compliance audit work underway with HM Revenue and Customs is concluded" [Emphasis added]

It appears that Defra followed HMRC's original guidance when they made the initial determinations, but that it was updated later, thereby moving the assessment goal posts, which led to the unexpected tax bill.

Chaplin warns firms of future danger: "Whilst it's common knowledge that HMRC guidance can rarely be relied upon in court, it seems rather disingenuous to offer a "stand by" commitment based on guidance that could change in the future. Firms don't own time machines. They should stick to relying solely on the case law."

This clear departure from the promise to "stand by" the results appears contrary to the claims made only a few weeks earlier by HMRC, in their evidence provided to the House of Lords Sub-Committee inquiry into Off-payroll working, where they claimed:

"It [CEST] is the only tool in respect of which HMRC will always stand by the result produced, provided the information entered remains accurate, and the tool is used in accordance with our guidance. In any compliance check, HMRC will not dispute an employment status determination that is in line with a correctly obtained CEST tool result."

"There is now a plethora of evidence demonstrating that HMRC's heavily caveated "stand by" promise isn't worth a row of beans, particularly when a future change in the guidance appears to invalidate any historic assessments made," says Chaplin.

CEST long reported flaws on substitution catch MoJ

The Annual Report and Account 2020-21 for the Ministry of Justice reinforce the longstanding charge against CEST that it relies too heavily on the case law test of substitution – an issue first reported by a ContractorCalculator FOI investigation as far back as August 2018.

The MoJ report states that HMRC audited the department's IR35 assessments (made between 6 April 2017 and 5 April 2021) and challenged their interpretation of the rules. HMRC then asked them to "revisit employment status determinations made for all off-payroll workers where their hiring managers had concluded their workers could send a substitute to deliver work instead of themselves." Following the compliance audit, HMRC concluded that incorrect determinations were made by the department."

Chaplin reasons that the MoJ should feel aggrieved with what's happened: "HMRC published the CEST guidance tool, claiming publicly that it was accurate and that it would stand by its results. Yet, despite widespread criticism on the over-reliance on substitution from many independent IR35 experts, HMRC chooses not to fix it. The MoJ used CEST in good faith and have now been stung with a £72.1 million tax bill.

"The private sector should take heed from the MoJ debacle," warns Chaplin, "particularly firms who have attempted to design services around the flawed notion that a substitution clause is an IR35 silver bullet."

Is HMRC's reasonable care guidance now flawed?

But, it all gets much worse. HMRC has accused the MoJ of acting carelessly, and Defra is also expecting to face that charge, which means they did not take reasonable care – a crucial part of the legislation.

The Ministry of Defence Report states, "HMRC found that the department had been 'careless' in its application of the Off-payroll working rules. As a result, it imposed a penalty of £15 million."

Defra's Report states that the investigation by HMRC is ongoing, but "It also assumes that HM Revenue and Customs (HMRC) would deem any incorrect assessments as careless, but the investigation is still to be finalised."

"This is alarming", says Chaplin, "because it appears to be contrary to HMRC's published guidance on reasonable care." The Off-payroll guidance (ESM10014) lists examples of behaviours HMRC considers as indicating clients taking reasonable care, which includes:

  • accurately completing and applying the results of HMRC's Check Employment Status for Tax (CEST) tool
  • applying HMRC guidance on determining the status
  • having someone with a good understanding of the work to be undertaken involved in the determination process

Defra and the MoJ are two of the largest Government organisations and would undoubtedly have received considerable help from HMRC for implementing the Off-payroll reforms correctly. They also committed to using HMRC's Check Employment Status for Tax (CEST) tool and followed HMRC guidance. But, they are both now facing charges of carelessness.

"The law on reasonable care (or carelessness) is based around negligence and requires knowing what was in the mind of the person at the time. HMRC provided the advice and guidance and populated the minds of those conducting the assessments, yet HMRC is now claiming their 'customers' are effectively negligent. It's beyond belief."

From 85% outside to 22% - what happened?

The reclassification figures at Defra are also cause for considerable concern.

They had initially assessed 85% of contractors as "Outside IR35" using HMRC's CEST tool and guidance but are now being told that it should have been 22%.

Chaplin says: "The scale of the errors produced by the CEST tool here is worrying. Defra followed HMRC's guidance and used CEST in good faith, resulting in them determining that 85% of the contractors were 'outside IR35'. However, despite this, HMRC is now telling Defra that 22% during that period should have been 'outside IR35'. This is against a backdrop of longstanding HMRC rhetoric saying that about a third of contractors should be 'inside IR35'.

"It's like the police training people how to drive properly, then fining all the trainees for reckless driving once they hit the road. It's frankly staggering."

CEST – fix or withdraw?

HMRC's recent evidence to the House of Lords also claimed that: "It [CEST] has been rigorously tested against established case law and settled cases to ensure it provides accurate results in line with current binding judgements."

"This is a longstanding claim by HMRC that has never borne scrutiny," says Chaplin.

ContractorCalculator's two year FOI investigation sought to obtain copies of the detailed test data which HMRC was relying upon to prove these claims. But it yielded nothing of substance until HMRC finally admitted they did not have such data.

When the Public Accounts Committee quizzed HMRC's CEO Jim Harra in March 2019 regarding the test data, HMRC responded in writing, stating that "We have not retained the scripts or other material from testing, including workshop attendee lists as this was not a project requirement."

On the one hand, HMRC claims that CEST is robust and accurate, yet on the other, it has no detailed test data of the claimed accuracy nor a list of the people who tested it.

"To suggest HMRC has no idea who tested the software and that they have no test data speaks volumes," says Chaplin. " HMRC built CEST using an Agile Software Development approach, a central tenant of which is detailed automated testing.

"For a tool of such importance, the supposed lack of rigour involved in its testing methodology is astonishing," comments Chaplin, whose career history includes commercial software development for leading UK financial institutions and legal practices.

At the same Public Accounts Committee in March 2019, Harra was quizzed over the apparent flaws in CEST that resulted in 92% of BBC presenters' status being reclassified as "Inside IR35". Rather than admit CEST was perhaps to blame, he pointed fingers at the BBC, describing its previous employment status practices as "quite a bit adrift."

Many years later, multiple government bodies now face a combined tax bill of £250 million, who all used HMRC's CEST tool in good faith and followed HMRC guidance. Yet still, HMRC claims CEST is accurate.

Published: 20 December 2021

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