HMRC suspects big firms of underpaying £1.4bn in employment taxes through IR35 rules

HMRC is promising to crack down on “hidden employees” as it suspects big firms are underpaying £1.4bn in employments taxes through IR35 rules.

The Revenue is concerned that some large businesses are underpaying Employers’ National Insurance contributions by hiding employees as self-employed when they should be classified as employees for tax purposes.

This could include both workers who are paid by businesses on a self-employed basis and those who are paid through a personal service company (PSC) and fall within the IR35 rules.

“Off-payroll workers are one of HMRC’s biggest priorities at the moment – even businesses that have sought to comply with the IR35 rules are finding themselves in the crosshairs,” said Steven Porter, a partner at law firm Pinsent Masons.

This comes after HMRC won a tribunal case against Alan Parry, the former Sky Sports football commentator, regarding whether he should have been taxed as an employee under IR35. The tax bill was £356,000.

In April 2021, the government changed the rules for off-payroll workers, which is known as IR35. The new rules imposed tax and compliance risks on large and medium sized businesses when engaging individuals through PSCs. Previously, the contractor was responsible for applying IR35 and paying any employment taxes that were due.

HMRC is said to be pursuing £1.4bn in tax as of March 31, 2022. According to Penny Simmons, a legal director at Pinsent Masons, this figure suggests that HMRC still believes that many large businesses are continuing to pay contractors on a self-employed basis, when they should be employees for tax purposes.

She notes that this could be because HMRC considers that large businesses are not applying the IR35 rules correctly. However, she adds that HMRC is questioning whether businesses should be paying individuals on a self-employed basis, even when the IR35 rules don’t apply because the workers are not engaged through PSCs.

Businesses need “robust on-boarding procedures”

Simmons goes on to explain that there is no single test for determining whether an individual is an employee for tax purposes, but rather a business needs to consider several factors. She notes that this can be complicated and can be difficult to apply.

In some cases, even when a business believes that it has applied the test correctly, HMRC may still disagree with the tax status determination, she added.

“Large businesses need to review how they engage off-payroll workers and manage employment tax risks. Businesses should ensure they have robust on-boarding procedures in place and are applying the IR35 rules correctly, whilst also having a process for making comprehensive employment tax status determinations for all workers to be paid on a self-employed basis.”

Pinsent Masons’ Porter also noted that businesses who engage large numbers of contractors (either through PSCs or as self-employed individuals) run the risk of HMRC investigations and potential penalties.

In recent months, HMRC has begun to levy penalties on businesses that have misapplied the IR35 rules having given them 12 months’ grace period following the IR35 rule changes.

“HMRC believes it may be missing out on more than a billion pounds a year from large businesses that are paying workers on a self-employed basis. Figures on that scale will push off-payroll workers to the front of the queue when it comes to HMRC opening investigations,” Porter said.