The Cabinet Office has set aside £38.5m to cover unpaid tax on contractors after HM Revenue and Customs concluded the department failed to take reasonable care in applying the off-payroll working rules, known as IR35.
The department’s annual report and accounts for 2025-26, published in September, state that HMRC concluded in October 2025 that the department’s historic processes “were inadequate” and that reasonable care was not taken. That finding exposes the Cabinet Office to a penalty of 15 to 30 per cent of the net tax, up to £8.9m.
In February 2026 management approved an “expedited settlement” and paid HMRC £15m on account. The accounts put the gross liability, including interest, at £38.467m, leaving a provision of £23.467m.
The figures were drawn together by IR35 Shield, an IR35 tax compliance firm, which reviewed every set of Cabinet Office accounts from 2019-20 onwards. According to its analysis, each set of accounts from 2020-21 to 2024-25 stated that the department “applied the off-payroll rules with care”.
Public sector bodies became responsible for deciding the IR35 status of their contractors in April 2017. Under HMRC’s off-payroll working guidance, a worker caught by the rules pays broadly the same income tax and National Insurance as an employee would, and the client generally decides the worker’s status.
HMRC began compliance checks on the Cabinet Office’s determinations in 2019, covering every worker engaged since April 2017.
The issue first appeared in the 2020-21 accounts as an unquantified contingent liability. The department said then that it had applied the rules “with care” but conceded it might be liable for tax on any incorrect determinations.
In 2021-22 the Government Internal Audit Agency (GIAA), the government’s internal auditor, carried out an IR35 compliance audit. The accounts do not disclose its findings. The same accounts said HMRC’s audit “has found no fault” so far, while warning the exposure “could potentially be a material figure”.
The 2022-23 note repeated this word for word. The 2023-24 note dropped the “no fault” line and reverted to the 2020-21 wording.
The 2024-25 accounts listed a further GIAA audit of “contingent labour (IR35)” without giving its outcome, and still said the department applied the rules with care. They also disclosed that HMRC had reached conclusions on four groups of workers and believed many classed as outside IR35 should have been inside. The Cabinet Office said it did not agree with “all aspects” of HMRC’s argument.
The 2025-26 accounts end that dispute by recording HMRC’s October 2025 conclusion and the settlement. IR35 Shield’s summary of the accounts records the potential penalty as “deemed remote”.
The department’s 2025-26 annual report also says spending on contingent labour in the core department fell from £39m to £32m over the year, as part of efforts to curb its reliance on outside staff.
The Cabinet Office is the latest public body to disclose an IR35 liability. Business Matters reported in February that the Department for Business and Trade would provide up to £104.4m to cover the Post Office’s outstanding IR35 tax bill.
In October 2025, Natural Resources Wales paid £14.6m to HMRC, including a £2.9m penalty suspended for 12 months, after errors in its contractor status determinations.
The Foreign, Commonwealth and Development Office’s latest accounts showed 438 of 500 contractor engagements determined inside IR35 in 2025-26, with its final liability to HMRC still to be agreed.
Dave Chaplin, chief executive of IR35 Shield, said: “For five years, the Cabinet Office told Parliament it had applied IR35 rules with care. HMRC has now concluded that it did not take reasonable care and that its historic processes were careless, thereby incurring a penalty on top of the tax. This raises serious questions about compliance at the very heart of government.
“The lesson for every organisation engaging contractors is that claiming to take reasonable care is not the same as being able to demonstrate it. IR35 determinations must be supported by robust processes, accurate information, and evidence that the rules have been applied properly. Getting it wrong can have consequences far beyond the original tax bill.”
