IR35 Update: CEST Tool Might Be Inaccurate

Contractors are furious after it was revealed that HMRC are ignoring Mutuality of Obligation (MOO) when deciding on IR35.

Let’s face it, the IR35 was never going to be an easy feat -  and especially not with the time between announcing the requirements and the deadline for being fully compliant was approximately 3 weeks.

Are you still struggling to fully grasp the basics? You can read our introduction to IR35 right here.

In a nutshell, the legislation was designed to combat tax avoidance by workers offering their services to clients via an intermediary. In other words, a contractor who would be an actual employee if the intermediary was not used. HMRC refer to such workers as “disguised employees”, and the financial impact can be rather significant: If caught by IR35, it can end up reducing the worker’s net income by 25%.

IR35 has been heavily criticized since its implementation, with tax experts arguing that it causes “unnecessary costs and hardships for genuine small businesses”.

The Inaccuracy of CEST

Several contractor consultancies, including the freelance advisory service ContractorCalculator.co.uk, believe that the tax agency’s Check for Employment Status for Tax (CEST) service is actually inaccurate.

CEST is a sequence of questions used by the HMRC to determine whether a contractor falls within the IR35 framework. If you are, you will be hit by taxation as though you were directly employed by the client - but without any of the benefits a full-time employee would receive.

The CEST issues stem from Mutuality of Obligation, known as MOO. According to British employment law, MOO refers to the obligation of the employer to provide work and the employee to accept it. Such a contract obliges the employee to do the work and the employer to pay. However, the CEST test does not include any questions regarding MOO since HMRC simply assumes it’s present in all contractor engagements.

The omission of MOO from CEST is rather significant. If there is no MOO, then the contract will likely be outside of IR35.

Fundamentally Flawed

In an attempt to defend their decision, HMRC published a paper where they stated the following:

“Where work is provided and remuneration is paid we will assume that there is mutuality of obligation and that a contract exists. (...) For the avoidance of doubt, the CEST online tool assumes that a contract exists or is being considered. We do not anticipate the tool being used outside of these circumstances”

Chief Executive of the Freelancer and Contractors Services Association, Julia Kermode, quickly went public to criticize the flaw: “Quite simply, MOO is an essential element of IR35 status, as borne out in recent cases, and until HMRC’s position is revised their CEST tool is fundamentally flawed by ignoring case law”.

Kermode was backed up by Dave Chaplin, CEO at ContractorCalculator, who stated that: “Judges have consistently told the taxman that simply having a contract is not sufficient MOO to be considered as a pointer towards an employment relationship.”

But what is really at stake here?

Well, if HMRC were to publicly admit that CEST is inaccurate, it would lead to a rather substantial number of taxpayers who would demand reassessment. It’s not long since Ian Wells, an IT contractor, won his appeal against HMRC to pay £26,000 in taxes under IR35 legislation.

This was a case which saw IR35 being described as so “ludicrously complex that not even HMRC can understand it”.