New tax rules could place administrative and tax burdens on many smaller employers, including those working in the mortgage industry according to a new National Audit Office (NAO) report.

The report looks at how new ‘IR35’ tax rules have been implemented in the public sector, and the potential issues facing the private sector after their introduction last year.

These IR35 rules were designed to prevent tax avoidance by ‘disguised employees’ working through personnel service companies. These were initially introduced in the private sector in 2016, but were amended in April 2021 to apply to companies and organisations working in the private and third sector. 

This NAO report says that the tax burden for non-compliance is likely to fall on both larger and medium-size employers, rather than their contractors, or their intermediary companies.

The NAO report says HMRC has the opportunity to learn lessons from the implementation of IR35 in the public sector. It concluded that these regulations achieved their primary purpose of reducing non-compliance and increasing tax revenue. 

NAO noted that within the first two years, at least 50,000 people were added to the payroll systems, and the net increase in tax revenue was £250m. But in the 2020/21 financial statements of government departments and agencies, it included a total of £263m paid, owed or expected to be owed in additional tax for failing to administer the reforms correctly.

However the NAO concluded that the public sector faced challenges with the initial roll-out, particularly because some bodies had little time to prepare and found it difficult to use the guidance provided by HMRC. 

The NAO said HMRC appears to have learned “several key lessons” enabling more support and time for the transition in the private sector. But it added: “Questions remain about the system for addressing incorrect determinations, with routes of appeal untested and tax burdens in cases of non-compliance likely to fall on employers.” 

It also pointed out that it will be far more difficult for HMRC to identify, monitor and address non-compliance across larger and more complex labour markets in the private sector. It warned that HMRC would need to manage these risks to ensure these reforms are successful.

The Federation of Small Businesses has said that the implementation of these IR35 tax rules added “further friction” to the labour market.

It adds: “This came at a time when the economy was in the midst of a pandemic and furlough was still prevalent. Now the economy is recovering, and furlough has ended the impact of this friction is becoming clearer.

“The process of complying with tax should be simple and non-burdensome. The more complex the process of compliance, the greater resource drain it is on small businesses [who] do not have dedicated tax teams so resources spend on compliance means resources diverted away from productive business activities.”