HMRC CEO Jim Harra 'not in the real world' on contractors and IR35

Jim Harra, chief executive of HMRC, has been mockingly accused of usually ‘not being in the real world’ when it comes to contractors and IR35.

Speaking to the Public Accounts Committee, Mr Harra admitted that the cost burden for PSCs reducing under the 2021 rules was based on such contractors foregoing having to pay to test their IR35 status.

But he conceded it was a “theoretical” cost (despite HMRC factoring it in to its forecasts), because “I acknowledge that in the real-world, 90% of them were not incurring those costs.”

“Mr Harra hits the real world,” PAC chair Meg Hillier MP retorted to his face.

A Labour MP, Ms Hillier was alluding to the NAO finding that HMRC estimates that last April’s off-payroll rules saved PSCs £8.7million, due to them “no longer having to make determinations.”

'What the costs would have been'

Addressing her committee, Mr Harra fessed up that the entire £8.7m figure is “based on the assumption that if we made PSCs comply with their obligations under the pre-reform methods” – which incidentally, would be practically impossible for HMRC to do, “that is what the costs would have been.”

Ms Hillier’s comment that Mr Harra “hits the real world” by admitting the £8.7m is based on nine parts fantasy one part truth (‘90% don’t incur those costs’) was said partly in jest.

But a former Office of Tax Simplification secondee, who was drafted into HM Treasury to help simplify the IR35 legislation before it was reformed isn’t laughing.

'Makes an ass of HMRC, and is infuriating'

Now co-founder at status advisory Bauer & Cottrell, ex-Treasury secondee Kate Cottrell told ContractorUK: “Having read the PAC session transcript, the adage ‘Never ASSUME as it makes an ASS of U and ME’ should be changed to ‘HMRC should never assume as it makes an ass of HMRC and all who work there.’

“For example, HMRC’s estimated costs to organisations we now know were based upon the ‘fact’ that contractors did not have to pay for IR35 assessments.

“But towards the end of its session, the PAC is told by HMRC’s CEO that actually, 90% of contractors did not pay for assessments anyway – to which PAC’s chair replies, ‘Mr Harra hits the real world.’

“So we see here that from the outset, HMRC figures have been based upon knowingly incorrect assumptions. That’s infuriating.”

'Happens from time to time'

At the session, and to try to help the awkward moment along by glossing over the admission that HMRC’s forecasted administrative burden for PSCs does not tally with the real-world, Mr Harra himself got in on his own slight.

In reply to Ms Hillier telling him in front of the rest of the committee -- and his two tax colleagues (HMRC’s Pete Downing and Nicole Newbury), that he had “hit the real-world,” Mr Harra mused: “It happens from time to time.”

But before the exchange (17:18:52 – 17:19:18), HMRC’s first permanent secretary actually went on the attack about the department’s forecasting of IR35 reform’s impacts.

That’s even though the forecasting has been mildly criticised by the National Audit Office, and outright slammed by the House of Lords Economic Affairs Finance Bill Sub-Committee.

'Long-standing methodology'

“Why did you use the minimum effort [for organisations] to comply as the benchmark [for forecasting] and not what organisations would do in practice?” asked PAC member Sarah Olney MP, sounding similarly keen on the real-world.

Mr Harra replied: “We have an established methodology for calculating the compliance costs for any policy measure that is of long-standing, and that is the methodology that we used in this case."

Before admitting a Lords' “recommendation” in 2020 forced it to adjust its costing, the boss of HMRC added: “So we calculate what we believe to be the costs that they are required to incur, in order to comply.”

'Proper evaluation'

In advance of the almost two-hour oral evidence session, Ms Hillier tweeted that alongside broaching “concerns” about the off-payroll rules’ application, the PAC would want to see whether HMRC had made a “proper evaluation” of the April 2021 rules.

The PAC’s report on that issue and others, “with a fair wind,” will be published in the Easter.

However, IR35 reform’s actual implementation costs and its actual administration costs are not the only figures that caught the tax authority out.

'Staggering £263million for getting IR35 wrong'

Asked if HMRC planned for ministerial departments to fall foul of IR35 status testing -- to the “extraordinary” tune of a “staggering” £263million (as Ms Hillier described), HMRC’s director for wealthy and mid-sized business compliance Ms Newbury confessed: “It was not in our planning.”

Newbury further said HMRC “had hoped” that all the educational “work that we had done” on IR35 (‘workshops, webinars, guidance’) “would have stopped that, but unfortunately it did not.”

More unforgiving, almost critical of HMRC’s departmental bedfellows, Mr Harra said: “Times [between HMRC’s final guidance and the April 6th 2017 commencement] were tight, but there was money being lost. And these bodies should have been able to step up and meet these obligations”.

'Key personnel didn't understand contractual framework on substitution'

Pressed on how Defra, MoJ and others got IR35 so wrong, Ms Newbury said despite been given an HMRC IR35 reform “masterclass,” the five departments’ “key personnel did not understand the contractual framework…[as to] whether they had a right to substitute.”

Rebecca Seeley Harris, an off-payroll adviser to organisations, revealed the CEST-substitution ‘fail’ in a ContractorUK article last month.

“Those that seemed to struggle with the rules more than others were central government,” Ms Seeley Harris began last night in a statement to ContractorUK.

“And [according to the PAC session] this was apparently down to the hiring manager ticking that there was no right to reject a substitute when their contractual arrangements didn’t back this up.   

“But what is even more interesting is that HMRC had not envisaged that the public sector bodies would get IR35 testing THIS wrong -- £250million-plus wrong.” 

'Public bodies should have been familiar with the concept'

According to Mr Harra, HMRC didn’t envisage it because “public sector bodies should have been familiar with the concepts because they make employment status decisions all the time.”

Spreading the blame to ministers, as well, he added: “Since 2012 they have also been obliged by the Cabinet Office to check the tax compliance of senior off-payroll appointees

“So there was a balance to be achieved between giving public bodies as much time as we possibly could to get ready with the fact that year on year the exchequer was losing money from non-compliance. That was the balance that ministers at the time decided to strike.”

'HMRC is blaming the public sector'

Formerly of the Inland Revenue, Ms Cottrell said: “HMRC is blaming the public sector for owing them £263million for not understanding contractual frameworks, despite getting an IR35 ‘masterclass.’

“But none of HMRC’s published underlying assumptions of costs are correct…and contractors in the public sector may be entitled to refunds but…[HMRC] cannot identify them.”

Cottrell says the “most interesting” aspect of HMRC’s evidence may be its assessment that just 15,000 PSCs are inside the new IR35 rules, per month, versus 240,000 PSCs projected to be affected and 180,000 PSCs projected to pay more tax as a result.

Both the HMRC projections were made prior to the April 2021 commencement.

'Tremendous impact'

“But this [15,000] does not account for those on agency payrolls, those moved to umbrellas or those employed directly. HMRC don’t know those numbers and won’t ever know,” Bauer & Cottrell’s co-founder says.

“Surely, this figure must demonstrate quite clearly that the rules have had a tremendous impact on behaviours, and bear no relation to all the [HMRC] assumptions previously made.”

But there is another aspect of HMRC’s evidence to the PAC which massively affects contractors.

And it’s an aspect that Treasury minister Lucy Frazer has denied is even a thing, let alone the statutory right of taxpayers who operate through their own limited company.

'Disagreeing contractors have the right to self-assess'

“Ultimately, if the engager says, ‘No, you are employed,’ and they [contractors] continue to disagree, they do have the right to self-assess to HMRC what they believe to be the correct tax treatment,” Mr Harra stated, at odds with Ms Frazer who wrongly described such self-assessing as inappropriate.

Two additional confirmations of using the self-assessment tax system to object to an engager’s inside IR35 tax treatment were issued by HMRC in the PAC session.

Another by Mr Harra, who even said HMRC would go into bat for contractors: “One facility that workers have here is that they have access to the CEST tool.”

“They can enter the facts into the tool, see what answer it gives them and, if it gives them an answer that says they are not within the IR35 rules and they can show that to HMRC, we would take action.

“There is no way that we would say, ‘You have to go to tribunal to get that changed,’ because they can self-assess”, he said.

Second, his HMRC colleague Ms Newbury echoed: “We pick that up either through people coming to us and raising concerns, or by seeing the small number of people who come for a refund as part of the self-assessment process”.

'Great mess'

While contractors might welcome the clarification in light of Ms Frazer’s denial in December, law firm ReLegal Consulting believes it highlights the sheer unwieldiness of the IR35 regime.

The firm said: “So apparently, HMRC will claim the tax from the public sector body, when they have misclassified, the contractor will then claim it back from HMRC. What a mess. 

“Ironically, we alerted HMRC to this point [back in 2020] but we only got a definitive answer several months ago, to clarify that there is no way for HMRC to offset the tax, because of the contractor’s limited company. HMRC scores an own goal!”

On Twitter and reaching out to both the PAC and HMRC, a user reflected: “It’s yet another great mess created by this government.”

'What HMRC is doing creates something else that loses tax'

Sounding not far off determining the same, or at least suggesting unintended consequences are getting the better of HMRC, was Craig Mackinlay MP.

A chartered accountant, Mr Mackinlay told the CEO of HMRC: “Sometimes you
don’t see that the next step in what you’re doing creates something else that loses tax. And you don’t really recognise the loss, whereas overall it creates a load of aggravation for a lot of people.”

The Tory MP was referring to IR35 reform forcing people to close down their PSC and extract income, albeit at the tax-advantageous rate of 10% thanks to Entrepreneurs’ Relief (or Business Asset Disposal Relief).

This ‘perversity’ contrasts the higher tax payments which would have been due, had IR35 reform not forced PSCs to close and instead kept them paying dividend tax, outlined Mr Mackinlay.

'Laughing accountants'

It wasn’t the only time in the PAC’s session that HMRC’s inquisitors were identified as tax professionals (which was made clear and declared at the start of the meeting).

“The accountants in the room are laughing at the idea that it might take weeks,” Ms Hillier told Mr Harra, referring to her asking the HMRC panel how long a challenge of inside IR35 status via self-assessment might take to come to fruition.

On behalf of the Revenue, Ms Newbury said: “If everyone co-operates and there are no challenges, it will take a few months. If it is complex and there are multiple reports, it can take years.”

“Years?” Ms Hillier said, almost checking her hearing.

'Blanketing running at 1% -- not in the real world it's not'

It is a half-question to HMRC which was sounded by the PAC chair but that does not appear in the PAC’s transcript of the session.

“Just a couple of things to pick up,” an interjecting Mr Harra said, sounding keen to get past “years?” hanging in the air for too long.

“First of all, we have some experience, with the 2017 reforms, of looking into what public sector bodies did. I think we may have found one case, but it is about 1% -- it is really small -- where we think there is evidence of blanket determinations.”

A Twitter user, a computer programmer shared: “I watched this [PAC evidence session featuring HMRC] and almost smashed my phone. Harra and his subordinates have NO IDEA of the terrible consequences this [IR35 reform] is having in the real world. Or if they do, they don’t care.”