Cabinet Office's £38.5m IR35 Bill: What "Reasonable Care" Really Means
The UK Cabinet Office has set aside £38.5m to settle an HMRC finding that it applied the off-payroll working rules carelessly, despite five consecutive years of annual reports telling Parliament that its IR35 processes were sound. For accounting firms advising engagers on contractor status, and for CFOs running internal compliance programmes, the case is a blunt reminder that a clean-looking paper trail is not the same as a defensible process. Robust crypto accounting software and broader compliance infrastructure aside, the principles at stake here apply to any organisation managing worker status determinations at scale.
The Timeline: From Reassurance to a £38.5m Provision
HMRC opened its review of the Cabinet Office's status determinations in 2019, examining every engagement dating back to April 2017, when the off-payroll rules first extended to the public sector. The department's annual accounts from 2019/20 through to 2021/22 were not silent on the matter. They told Parliament explicitly that the rules had been applied "with care" and, in subsequent years, that HMRC had found "no fault" so far.
How the settlement was structured
In October 2025, HMRC concluded that the Cabinet Office's historic processes were inadequate. The department agreed an expedited settlement in February 2026, paying £15m on account and providing for the remaining £23.5m. It expects HMRC to suspend the associated penalty, an outcome that echoes the conditional suspensions granted to the Ministry of Justice and the Home Office in comparable investigations.
The shift in outside-IR35 determinations
The annual accounts record a striking swing in how the department classified its contractors. In 2019/20, 91% of new engagements in the core department were placed outside IR35. By 2025/26, that figure had collapsed to 3%. No annual report in the intervening period explains the methodology behind either position. That absence of documented reasoning is itself a signal worth noting.
The Legal Standard: What "Reasonable Care" Actually Requires
Careless inaccuracy penalties under Schedule 24 of the Finance Act 2007 hinge on whether a failure to take reasonable care caused the underpayment. The benchmark is objective: what would a prudent and reasonable taxpayer in the same position, exercising reasonable diligence, have done? A wrong answer reached through a genuinely careful process does not automatically attract a careless penalty. The error itself is not the test; the process that produced it is.
Reliance on professional advice and tools
Case law provides some shelter for taxpayers who rely on advisers or tools, but the protection is conditional. Reliance is treated as reasonable only where the source appeared competent, the taxpayer supplied full and accurate facts, and the taxpayer engaged critically with the output to the extent their own knowledge permitted. For a central government department with access to HMRC's own guidance, specialist HR and legal staff, and HMRC's Check Employment Status for Tax tool (CEST), those conditions set the bar high.
The CEST Substitution Problem
Although the Cabinet Office has not publicly confirmed which tool or methodology it used, the pattern of its determinations invites comparison with other government bodies investigated by HMRC. At the Ministry of Justice, which used CEST, HMRC focused its review on every determination where a manager had indicated that the contractor could send a substitute. CEST returns an outside-IR35 result as soon as a right of substitution is confirmed, largely independent of the other facts entered. That mechanical approach sits uneasily with the Supreme Court's reasoning in Pimlico Plumbers, which made clear that a contractual right of substitution must be genuine and practically exercisable to carry weight in the employment status analysis.
The pattern across government departments
The MoJ's £15m careless penalty was suspended on the condition that it revisited every outside determination. The Home Office's £4m penalty came with the same condition. Whether the Cabinet Office's 91% outside rate in 2019/20 rested on the same substitution-ticking approach remains publicly unconfirmed, but the structural similarity is hard to ignore. Until HMRC publishes a more detailed account of what the Cabinet Office actually did wrong, the most prudent working assumption is that determinations driven by a single favourable factor do not satisfy the reasonable-care standard.
Implications for Accounting Firms and CFOs
The Cabinet Office case is not an edge case involving an obscure employer. It is a department at the centre of government, with professional staff and statutory reporting obligations, that managed to receive a careless finding after half a decade of reassuring disclosures. That should recalibrate how advisory firms and in-house finance teams think about IR35 compliance programmes.
Documentation is not a substitute for process
Annual accounts that describe care being taken are not evidence that care was taken. HMRC's investigation looked behind those statements and found the underlying processes wanting. For accounting firms advising clients, this means the deliverable cannot be a status determination form in isolation. It must include a documented, case-law-aligned reasoning chain for each engagement, one that a tax inspector could follow without needing to take anything on trust.
Single-factor determinations carry disproportionate risk
If a determination rests primarily or entirely on one indicator, whether substitution, control, or mutuality of obligation, it is unlikely to survive scrutiny. Each of the three key employment status tests needs to be addressed on its own merits, with the facts recorded as they actually exist rather than as the contract describes them. Contracts that assert a right of substitution but where no substitution has ever occurred, or where the operational reality makes substitution impractical, are exactly the kind of gap HMRC has been targeting across the public sector.
Conditional penalty suspensions carry their own obligations
The suspension of careless penalties at the MoJ and the Home Office was not unconditional forgiveness. It required those departments to audit every outside determination and correct errors found. Firms advising clients who have historically relied on CEST outputs, particularly where substitution was the decisive factor, should treat a prospective HMRC enquiry as a realistic scenario and consider whether a voluntary compliance review now is preferable to a compelled one later.
The "no fault so far" trap
The Cabinet Office's accounts described HMRC finding no fault through the early years of the review. That phrasing reflects the status of an ongoing investigation, not a clearance. Advisers should be cautious about communicating interim investigation updates to boards or audit committees in language that could later read as a clean bill of health. The Cabinet Office's experience shows the gap between "no finding yet" and "no finding ever" can close very quickly.
Practical Steps for Advisers and In-House Teams
The Cabinet Office settlement points to specific process gaps. Addressing those gaps now, rather than after an HMRC review letter arrives, is where the value lies.
Review the methodology behind existing determinations
For every contractor currently placed outside IR35, the question is whether the determination is supported by a complete, documented analysis of the three core tests, grounded in the actual working arrangements rather than the contract wording. Engagements where the outside determination was reached quickly, or where CEST was used without supplementary analysis, warrant immediate attention.
Check the factual accuracy of substitution claims
Following the pattern seen at the MoJ, any outside determination where a right of substitution was the primary or sole basis needs to be tested against reality. Has a substitute ever actually been provided? Is the right practically available given the skills required and the operational context? If the honest answer is no to both, the determination needs to be revisited.
Align documentation with case law, not just CEST output
CEST is a starting point, not an end point. The underlying case law, including Pimlico Plumbers and the body of IR35 tribunal decisions, requires a holistic assessment of the overall picture. Determinations that cannot be defended by reference to that case law, regardless of what CEST returned, are exposed. Firms with large contractor populations should consider whether their current documentation standard would satisfy a Schedule 24 reasonable-care defence.
Revisit disclosures to boards and audit committees
If a client's accounts or board papers have described IR35 compliance in broadly reassuring terms, it is worth reviewing whether those descriptions accurately reflect the underlying process quality. The Cabinet Office's five years of positive disclosures did not reflect what HMRC eventually found. Boards and audit committees need accurate information about compliance risk, including the risk that a process which looked adequate may not meet the HMRC standard under scrutiny.
Frequently Asked Questions
What is a careless inaccuracy penalty under Schedule 24 FA 2007?
Schedule 24 of the Finance Act 2007 imposes penalties where a tax return contains an inaccuracy that results in an underpayment and that inaccuracy was caused by a failure to take reasonable care. The penalty rate for a careless inaccuracy is typically 30% of the potential lost revenue, before any reductions for disclosure and cooperation. A deliberate inaccuracy attracts a higher rate. If a taxpayer can show the error was neither careless nor deliberate, no penalty applies.
Can a careless penalty be suspended, and what does that involve?
Yes. HMRC has discretion to suspend a careless penalty for up to two years where it considers that suspension will help the taxpayer avoid similar errors in the future. Suspension is conditional on the taxpayer meeting specific requirements set by HMRC, typically reviewing and correcting the processes that led to the error. If the conditions are met by the end of the suspension period, the penalty is cancelled. If not, it becomes payable in full.
Does using CEST automatically satisfy the reasonable-care standard?
Not necessarily. CEST is HMRC's own tool, and HMRC has stated it will stand behind results produced by it, provided the facts entered are accurate and complete. However, where the facts entered do not reflect the real working arrangements, or where a single factor such as substitution is allowed to drive the result without critical examination, the reasonable-care defence is weakened. The MoJ and Home Office cases suggest HMRC is willing to challenge determinations where the substitution answer was applied without interrogating whether the right was genuinely exercisable in practice.
What should a firm do if a client's outside determinations relied heavily on substitution?
The priority is to assess whether each substitution right is genuine, meaning whether it has been exercised in practice or could realistically be exercised given the skills and operational context of the engagement. Where it cannot be, the determination should be revisited and, if necessary, corrected with a voluntary disclosure to HMRC. Voluntary disclosure before an HMRC enquiry opens generally attracts lower penalties and more cooperation credit than a correction made under enquiry.
Is this relevant only to public sector engagers?
No. The off-payroll rules extended to large and medium private sector engagers in April 2021. The reasonable-care standard and the Schedule 24 penalty regime apply equally in the private sector. The government investigations have attracted attention because the sums involved are large and the accounts are public, but the legal framework and HMRC's enforcement approach are the same for any in-scope private organisation.
Source: AccountingWEB