The IR35 legislation can be daunting for contractors, especially if you’re worried that you’ll be caught. The tax legislation was launched by the UK government in an attempt to penalize ‘disguised employees’ who are getting away with paying less tax by operating through a limited company. The IR35 rules and IR35 test determine whether you’re operating within the IR35 legislation and should be paying more tax than a legitimate contractor.
What is an IR35 investigation?
An IR35 investigation begins with a letter from HMRC saying that they are checking your tax records, this letter will also ask you why you consider yourself as self-employed. They will assess your answer and if they don’t accept this, a detailed investigation will be launched. This can last months or even years and will involve gathering evidence and statements from you and your client. The case can often end up at tribunal where you will fight your case as a self-employed contractor and a decision will be made as to whether you’re working inside or outside the legislation.
What triggers an IR35 investigation?
HMRC do not give too much away when it comes to the criteria that they use to decide if an investigation should be launched, and it’s unlikely that this information will ever be released. However, there are some factors that affect how common an IR35 investigation may be.
Working in a certain sector
Contractors in certain sectors are more prone to an investigation than others if the HMRC believes this industry to be medium to high risk when it comes to tax avoidance. This list of sectors can change with time as some industries become more compliant than others. In the past, specific campaigns have included doctors, teachers and dentists and all industries can find themselves under scrutiny.
The Transparent Benchmarking team
There is also the Transparent Benchmarking team who operate as part of HMRC, part of their job is to monitor contractors and investigate if they discover something of interest. This team has access to the average contractor in a range of industries and can look at the average earnings of a contractor who is a painter for example. If a contractor’s profits or business expenses look odd compared to their ‘profile’ this can look suspicious. Other triggers of an investigation include contractors who meet risk criteria and suspicious findings from payroll, VAT and corporation tax payments.
Sophisticated software
At one time, random IR35 investigations were launched in an attempt to catch tax avoiders. However, technological advancements mean that the Revenue can carry out more calculated investigations. Sophisticated software can pick up on suspicious behaviours or company profits and this could also be a reason to launch an enquiry.
HMRC’s IR35 contract review service
When contractors are in doubt about their IR35 status, some opt to take advantage of HMRC’s contract review service. Although this can be a helpful source of advice and consultancy, it can also lead to an unwanted investigation if it is found that the contractor is operating within IR35. Instead, self-employed workers should seek legal advice from a third party which will not result in a direct investigation if the contract is found to be non-compliant.
Anonymous tip-offs
Unfortunately, not everyone wants contractors to be found outside of IR35. In fact, it has been reported, that partners or spouses who have some sort of grudge against their partner have been known to make a report about their IR35 status. Knowing that this will result in an investigation, the aim of these reports is to presumably ensure that their partner pays more tax than they are currently doing. A tip-off like this would start as a general tax investigation but would be handed over to the specialist IR35 units when it is realised that a contractor is involved.
The IR35 investigation process
As mentioned earlier, the first stage of an IR35 investigation involves a letter that HMRC will send to the contractor. As part of this letter, contractors will be asked to justify their IR35 status and may be asked to provide information relating to past, present and future contracts. At this stage, you can request the help of legal representation (you would be automatically entitled to this as part of some IR35 insurance agreements) who will deal with all correspondence between you and HMRC. It is recommended that you do seek the advice of a specialist at this stage as HMRC can use a range of tactics to catch a contractor out and not everyone is prepared for this.
In response to this letter, you will collect any evidence of your IR35 status to prove that you’re operating outside of the legislation. Types of evidence would be your contractual agreements and a contract review. You can also present a Confirmation of Arrangements letter to HMRC which is signed by you and your client to prove that you’re both in agreement of the IR35 status that you’ve been deemed to have.
To find out more about your working situation, it’s understandable that HMRC will get in touch with your client. This is usually the case when they are unsatisfied with the response that they have received in the previous stage. It’s a good idea to maintain contact with your client and educate them on the importance of the situation before they make a statement. This evidence is crucial to an IR35 investigation and an IR35 specialist can educate your client on the situation.
Once HMRC has spoken with the client, a decision will be made as to whether the contractor is inside or outside the IR35 legislation. If they are found to be inside, an assessment will be carried out to determine how much tax and National Insurance payments are owed. Bear in mind that a penalty can also be added on here if it is determined that the tax avoidance was done with intent.
Following this, the contractor has 30 days to appeal the decision made by HMRC, this will take the case to a tribunal. It can take a while for the case to enter a tribunal court and in the meantime, contractors can use HMRC’s Alternative Dispute Resolution process. Within this process, the case is reviewed by an HMRC inspector who is not involved with the case. It is designed to give someone a fresh look at the situation and evaluate what they think the outcome should be. A decision here that the contractor is outside IR35 can close the case without the need for a tribunal.
If the Alternative Dispute Resolution process is unsuccessful, the tribunal will go ahead. Here, HMRC and your legal representative will collate evidence to present to the judge. Don’t expect a decision on the day though, it can take months for a final decision to be made by the judge. When a decision is made, the contractor has another opportunity to appeal the decision which would take the case to an upper tax tribunal. Here, further evidence will be examined, and more witnesses will be called to the stand.
What are the consequences of the investigation?
As we discussed before the consequences of the IR35 investigation are significant. First of all, it is not a simple or straightforward process and it is something that can last for months or even years. The stress of an investigation like this can take its toll and affect the running of a freelance or contracting business.
In addition to this, there are the financial implications of being caught within IR35. The amount that the contractor owes is based on the ‘deemed payment’ that HMRC calculates and is made up of owed tax and National Insurance contributions. It would not be uncommon for interest and penalties to be added onto this amount if it is found that tax avoidance was intentional. You can use an IR35 calculator to find out how much you would owe if you were found to be operating within IR35. Bear in mind that HMRC can examine contracts made within the last six years so you may owe money from multiple contracts.
How can you prepare for an IR35 investigation?
Although we may not know exactly what triggers an IR35 investigation, there are actions that you can take to prepare for one.
First of all, you can conduct a contract review personally or request the help of an IR35 specialist. They will inform you if you are acting outside of the legislation and you can take action to amend this before you accumulate owed funds. You should also educate yourself on the legislation so that you can ensure any future contracts are compliant and you aren’t caught out.
Taking out IR35 insurance is another way to prepare for an IR35 investigation. Depending on the type of cover that you choose, you may be presented with expert representation and have the amount owed covered by the insurance company if it is determined that you’re inside IR35. Seeking legal representation without your insurance can cost a significant amount of money as you will most likely have to pay an hourly fee. Instead, insurance can cover you for this and take the stress out of HRMC’s investigations and potential tribunals.
Operating through a third party is another way to protect yourself from IR35. Umbrella companies for example act as an employer for contractors and are therefore fully HMRC and IR35 compliant. With an umbrella company, you will be matched with clients who are looking for skills like yours, but you won’t need to worry about administration such as contracts and therefore will not be liable for any funds. You can use the form on this page to look for umbrella companies that match your requirements.
As we can see, there is a range of triggers that may lead to HMRC investigating your working situation and we can’t 100% say how common they are. It’s fair to say that you can never be too careful when it comes to IR35 and all contractors and freelancers are at risk of being investigated. We can see how long and stressful the process can be and it’s best to protect yourself with education on the legislation, insurance and potentially going through a third party.
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