Cabinet Office IR35 Penalty: What It Means for Contractors

Tax Queen

Tax Expert @ Pie

5 min read

What You Need to Know

This story doesn't change any tax rates or Self Assessment deadlines, and it won't add anything to your tax bill directly. If you work through your own limited company or take on contractors yourself, though, it shows how HMRC deals with status decisions it thinks were made carelessly.

What you need to do is simple. Keep evidence of how your working arrangements were decided, keep a copy of any status decision you receive, and make sure your Self Assessment return shows the right type of income.

What Happened at the Cabinet Office

The Cabinet Office has set aside £38.5 million to cover unpaid tax on contractors it took on. In October 2025, HMRC concluded that the department's past IR35 processes were inadequate and that it had failed to take reasonable care.

HMRC's review began in 2019. It covered every contractor taken on since April 2017, when public bodies became responsible for deciding IR35 status [Editor Note: Unverified figure - check against HMRC guidance]. For years the department's annual reports said it had applied the rules with care. The finding against it was then confirmed in its 2025-26 accounts.

What IR35 Means

IR35, officially called the off-payroll working rules, applies when you provide your services to a client through your own intermediary. This is usually a limited company known as a personal service company. If you would have been an employee had you worked for that client directly, the rules make sure you pay broadly the same Income Tax and National Insurance as an employee would.

In most cases the client decides your status. If you work for a small client outside the public sector, your own company makes that decision instead. The rules are unlikely to apply if you work through an umbrella company, and our guide to how umbrella companies work for freelancers and contractors explains that route.

When a client decides the rules apply, it should give you a status determination statement (a written decision with its reasons). The deemed employer, meaning whoever pays your company, then takes off Income Tax and employee National Insurance before the money reaches you.

How Much the Cabinet Office Is Paying

The department's total bill, including interest, is £38.467 million. It agreed a fast-tracked settlement in February 2026 and paid HMRC £15 million on account (an upfront payment towards the final bill). It has set aside £23.467 million for the rest.

Penalties come on top of this. According to the source, a careless finding lets HMRC charge between 15% and 30% of the net tax due, which here means up to £8.9 million [Editor Note: Unverified figure - check against HMRC guidance]. The department expects HMRC to suspend the penalty and hasn't set any money aside for it.

The department's approach changed sharply over time. In 2019-20 it placed 202 of 222 new engagements outside IR35, or 91%. By 2025-26, only 2 of 65 were outside, around 3%.

What This Means for Your Tax Return

If You Work Through Your Own Limited Company

If a client treats a contract as inside IR35, tax and National Insurance come off your fees before they reach your company. As a company director you may still need to file a Self Assessment return. Keep the payment statements so that what you report matches what was taken off.

Student loan repayments are an easy thing to miss. HMRC guidance confirms that deemed employers don't take student or postgraduate loan repayments out of off-payroll fees. That means you must register for Self Assessment and pay them through your tax return.

If You Are a Sole Trader or Hire Help

The off-payroll rules are aimed at people who work through an intermediary, so they don't normally apply to sole traders working directly for clients. Your employment status still matters, though. If a client could argue you are really an employee, contracts, invoices and evidence of how you work will protect you.

If you take on other freelancers yourself, remember that HMRC looks at the evidence behind a decision, not just a statement that you took care. HMRC's Check Employment Status for Tax (CEST) tool can help you reach a decision, but you should still write down the facts you relied on. The source notes that the department's reports never said whether it used CEST.

Keeping Records That Stand Up to HMRC

The Cabinet Office case started as a review of status decisions and ended with a bill of several million pounds. If you ever face a similar enquiry, knowing what happens during an HMRC compliance check will help you get the right paperwork together.

To HMRC, reasonable care means taking the steps a sensible person would take to get their tax right. For you, that means clear records of income, expenses and contracts that you can produce quickly. Our guide to HMRC digital record keeping rules for freelancers covers what to keep and how.

Self Assessment returns for the 2025-26 tax year are due online by 31 January 2027. Now is a good time to check that your contract income, any tax already taken off and any student loan amounts are recorded correctly.

Getting Your Contract Income Right

In this story, the department's problem was not having enough evidence to back up its decisions. On a smaller scale, the same applies to your own return. If your income, deductions and paperwork all match, an HMRC question is far easier to answer.

If you mix contract work with other freelance income, Pie Tax is self-assessment software that brings your income into one place, sorts your allowable expenses and files your Self Assessment return to HMRC. That gives you a clear record if your status or your figures are ever questioned.

If you'd like your records in order well before the January deadline, Get started today for free.