IR35 tax investigations fall to five-year low as HMRC fails to tackle avoidance

HMRC has missed its target to open at least 230 tax evasion enquiries per year as part of its strategy to clampdown on disguised employment, and in resolved cases it has only recovered on average £2,240, down from £20,000 a decade ago, according to data obtained by law firm Nockolds

HMRC opened 192 IR35 enquiries into contractors in the most recent tax year (2013/14), 25% fewer than in 2012/13 and substantially less than ten years ago, when the tax authorities were investigating around 1,000 cases a year in 2003/04.

Over the ten-year period, the tax yield has slumped to the lowest level in five years. HMRC netted just £2,240 per enquiry in the most recent tax year, down from a peak yield of £20,339 per IR35 enquiry in 2011/12.

HMRC accumulated £1.2m from 59 enquiries in 2011/12, compared to just £430,000 from the 192 enquiries in 2013/14.

Despite the creation of a number of specialist HMRC teams and its repeated pronouncements about a commitment to strengthen its risk assessment criteria so that resources are targeted at the highest yielding cases, this strategy appears to have failed.

According to Nockolds, the failure of HMRC to clampdown on disguised employment despite the surge in freelancing over the last few years and scandals such as the revelation of 25,000 off-payroll contracts at the BBC, raises questions about the usefulness of existing employment status tests and suggests a radical overhaul is needed.

Darren Hayward, managing partner at Nockolds and an employment lawyer, said: ‘HMRC has come under huge political pressure to clampdown on disguised employment but they seem to be going backwards.

‘Far from targeting the highest risk cases, HMRC appears to be pursuing very marginal enquiries.

‘It is likely that a significant number of the 192 cases in 2013/14 yielded no tax whatsoever.’

The tax yield has slumped to the lowest level in five years. HMRC netted just £2,240 per enquiry in the most recent tax year, down from a peak yield of £20,339 per IR35 enquiry in 2011/12.

Hayward added: ‘There has been a surge in the formation of one person companies and freelancers operating as sole traders since the recession.

‘It seems highly unlikely that of the hundreds of thousands of people who now work in this way just a couple of hundred are disguised employees.’

IR35 enquiries involve the accumulation of evidence, such as contracts, both from the personal service company and organisations they work for, as well as whether the day-to-day working reality reflects the contract.

Employers, however, have become increasingly sophisticated in ensuring that contracts are drafted in such a way that HMRC cannot deem a contractor to be an employe from a review of the contracts alone, according to Hayward.

He said: ‘The tools at HMRC’s disposal to tackle disguised employment are not fit for purpose.

‘Employment status enquiries are complex and often hinge on eyewitness testimony, making it very difficult to decisively prove whether someone is an employee or not.’

Nockolds says that IR35 enquiries can take months, which suggests that the current yield from interventions may not be a valuable use of HMRC’s time and resource.

Since the Coalition came to power in 2010 there have been several consultations looking at employment status, most recently a discussion paper by the Office of Tax Simplification (March 2015).

One suggestion is referred to as the 80% rule, which says that if a limited company contractor or self-employed freelancer derives 80% or more of his/her income from a single source they should be deemed an employee of that organisation.

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