IR35 Compliance And Protection
Navigating the intricate landscape of UK tax legislation is no easy feat, especially for contractors. Amidst the myriad of regulations, one term stands out prominently: IR35. But what does IR35 compliance look like, and how can you protect yourself against an HMRC IR35 investigation?
In this comprehensive guide, we delve deep into the heart of IR35. Whether you’re an aspiring contractor or a seasoned veteran seeking clarity, this guide aims to demystify IR35, empowering you with the knowledge to make informed decisions and remain compliant.
HMRC IR35 Investigation Trigger
HMRC carry out several thousand random inquiries annually; anyone can receive notice of an IR35 investigation. Contracts can be evaluated up to six years in the past to see where legislation should have applied.
Contractors can also trigger an IR35 enquiry due to exhibiting certain suspicious behaviours. HMRC monitors all businesses and individuals via their submissions (i.e. VAT Returns, Confirmation Statements, Company Accounts, Self-Assessment Tax Returns), using this data to refine their risk profiling and targeting strategies.
HMRC seeks to narrow those cases subject to investigation by considering a range of factors, including engagement patterns, the nature of the company, the sector of operation and financial irregularities. They prioritise individuals for review if they see any indication that the limited company is merely a vehicle of convenience instead of a genuine business.
HMRC’s systems are likely programmed to look for identifiers like an individual operating through a limited company who is the sole director, has a spouse as a shareholder, has changeable turnover, a fluctuating gross profit rate, minimal expenses and pays the minimum wage but significant dividends.
The subsequent investigation may not find the individual inside IR35; indeed, many legitimately outside IR35 contractors operate this way.
IR35 Investigation Process
IR35 enquiries are lengthy, complex, and technical, often taking multiple years to conclude. Broadly, though, the investigation can be split into three main steps:
i. Request For Information
HMRC send a letter referring to the contractor referring to a ‘Check of Employer Records’. The letter requests specific information, such as income breakdowns, work contracts, and reasoning as to why IR35 does not apply to the business.
If you are going to contact a tax advisor or IR35 specialist, it should be at this stage of the process before you respond to the letter.
If you respond with adequate evidence to show you’re not within IR35, HMRC will close the enquiry. If, after examining the written contracts, HMRC thinks that IR35 may apply, they’ll send another letter asking for a face-to-face meeting with you as the director of your company or as a member of your partnership.
By accepting HMRC’s invitation for a face-to-face meeting, the enquiry can usually be concluded more quickly as questions can be answered immediately. If you don’t accept HMRC’s invitation for a face-to-face meeting, HMRC will continue their enquiry by writing to you.
ii. Review of Information
HMRC will review the information provided and the day-to-day working arrangements that are in place. They do not rely solely on the information you have provided; instead, they contact any parties they think might have relevant information.
During their review, HMRC assesses whether you are a disguised employee. They consider whether the engagement would be one of employment or self-employment in the absence of the service company.
iii. HMRC's Decision
Once HMRC concludes its review, a letter informing you of its decision will be issued. If they decide your records are accurate and you are indeed outside IR35, nothing further happens.
If they decide your contract is disguised employment and should originally have been classified as inside IR35, a determination is issued. The determination outlines any additional income tax, National Insurance owed, and any late payment interest and penalties.
You have the right to appeal HMRC’s decision, a process that involves a review of the case by an independent tribunal.
Consequences of Getting IR35 Wrong
Being investigated by HMRC does not automatically mean you are a disguised employee. If you take the investigation seriously, seek professional advice, and your contract is genuinely outside IR35, you should be fine.
However, if HMRC determines your status assessment is wrong and you have incorrectly been working outside IR35, additional income tax and National Insurance is owed on the work performed. Depending on the circumstances involved, HMRC also has the discretion to issue a penalty.
The severity of the penalty is based on the reason for the inaccurate determination. If HMRC deems the responsible party:
- Was unaware or careless but didn’t know the assessment was inaccurate, they can be liable for a penalty of 30% of the tax bill.
- Was deceptive and knew the contract was within IR35 but chose not to act, they can be liable for a penalty of 70% of the tax bill.
- Actively intended to conceal the employment status and purposely engaged in tax avoidance activities, they can be liable for a penalty of 100% of the tax bill.
Who is Responsible?
The party responsible for paying the additional tax liabilities, late interest, and penalties is the same party responsible for performing the original Status Determination Assessment. This depends on the client’s industry, business size, and location, with further detail provided in our guide on IR35 Assessments?
In summary, the liability lies with you as a contractor if you provide services to a client in the private sector classed as a small company or provide services to a business classified as ‘wholly overseas’.
The consequences of getting IR35 wrong can potentially be crippling. Legal fees, taxes, interest, and penalties can all follow an HMRC investigation. Although the recent reforms place responsibility on the fee payer in most circumstances, there is still a significant downside for contractors involved in an IR35 investigation.
Maintaining IR35 Compliance
Beyond opting to move Inside IR35, there is nothing you can do that will eliminate the possibility of an HMRC investigation altogether. There is always the chance that you receive that dreaded letter. All you can do is ensure your contract and working practices are outside IR35 and mitigate the potential costs of an investigation through insurance.
i. IR35 Contract Reviews
Many companies specialising in contractor tax legislation or insurance offer independent IR35 contract reviews. These contract reviews provide an assessment of both your contract and working practices.
Ranging from £50 to £150, depending on the complexity of the feedback provided, an IR35 contract review will give an expert opinion on whether the contract sits inside or outside IR35.
They aim to identify clauses where HMRC may find an issue and often provide a list of recommended changes. These proposed changes afford you the opportunity to restructure any contractual provisions or working practices that may not be IR35 compliant.
By proactively undertaking an IR35 contract review, you demonstrate to HMRC that you have taken ‘reasonable steps’ to ascertain that your status lies outside of IR35. HMRC look favourably on this, and it will potentially reduce any penalties owed in the unlikely event a ruling should go against you.
ii. IR35 Insurance
HMRC can open an IR35 enquiry at any time for any reason. These investigations can be lengthy and costly, and without the guidance of a tax legislation expert, they can be challenging to defend. Having adequate IR35 insurance is therefore critical to ensuring peace of mind.
IR35 insurance primarily protects contractors from the extreme costs that can follow an IR35 enquiry. Depending on the policy, IR35 insurance can cover everything from expert representation to any tax liabilities, interest and penalties owed at the end of the investigation.
Although IR35 insurance is not mandatory, many contractors prefer to take out a policy to ensure someone with experience is fighting their corner should the worst happen. Qdos are a specialist insurance provider that offers comprehensive IR35 contract assessments and tax enquiry insurance.