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Essential guide to IR35 investigations for contractors

An IR35 enquiry can be daunting, especially when you’re managing it on your own. Employment status is a complex and grey area of tax, and an HMRC investigation can be time-consuming and stressful.

With new off-payroll working rules now in place, tax experts from the Federation of Small Businesses explain what’s involved in an IR35 enquiry.

Please note this is not a substitute for legal or tax advice. You should always speak to a qualified tax advisor for professional guidance.

What triggers an IR35 investigation by HMRC?

IR35 enquiries will seek to determine whether your employment status for your contracts as outside IR35 is correct. Responsibility for determining your status as inside or outside IR35 now lies with the end-client under the new legislation, unless they’re eligible for the small company exemption in which it case it remains your company’s responsibility and liability.

HMRC has never publicised its approach to selecting enquiries, but there has been a thread running through many. End client engagers have tended to be large businesses – including public sector bodies, often in banking and finance, oil and gas, and more recently the media – which in recent years may have been prompted by the intermediaries reporting, which agencies have to undertake every quarter.

What is also attractive to HMRC is where the contractor is paying themselves a low salary and taking the largest portion of their remuneration in dividends, because this is where the savings in National Insurance Contribution arise and where the largest source of uncollected tax may lie.

HMRC are also clamping down on contractor tax avoidance schemes that have cropped up in recent years, which, of course, you should not take part in.

What happens during an IR35 investigation?

HMRC enquiries are typically lengthy and complex, so every contractor’s experience will be different.  “IR35 enquiries are extremely detailed, based on case law and interpretation of facts. They are highly technical and often take several years to conclude,” says Jacqui Mann, Senior Tax Consultant at FSB Tax Investigation Protection.

A request for information

A letter from HMRC through your door referring to a check of employer records, also known as IR35 compliance, is the start of an enquiry.

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“The opening letter will request details and information for the year of enquiry, and give you a deadline for a written response,” says James Cordiner, Tax Investigations Manager at FSB Tax Investigation Protection. “It’s at this stage that you should contact a tax advisor, or FSB if you’re a member, before you take any action. This way, you’ll have a professional on your side from the beginning to help you handle any correspondence with HMRC. They will have years of experience and will know what to look out for.”

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Your Status Determination Statement

A legal requirement of the new legislation is for the end client to issue a Status Determination Statement, which determines your employment status for tax purposes only following an IR35 assessment. This must be undertaken with reasonable care by your client.

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You should receive a copy of your SDS in writing as evidence of why the engagement is inside or outside IR35, and you have a right to challenge the decision with a requirement for your client to respond to that challenge within 45 days.

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What are HMRC looking for?

During an IR35 investigation, HMRC assess whether your employment status is correct. There are three main factors used to determine employment status and whether your contract is for services or employment. HMRC will typically review your contracts and put your working practices under a microscope to establish whether your work falls inside IR35 legislation.

  • Control
    As an independent contractor, you should have control over how you do your work. If your contract demonstrates that you will be supervised or can be moved from task-to-task, this may indicate your engagement is inside IR35.
  • Mutuality of obligation
    This covers whether there is a commitment to offer and accept work, as it would be if you were an employee turning up for your shifts every week. Your contracts should make it clear that you’re working on a project basis.
  • Personal service
    You should be able to show that your personal service is not a requirement of the engagement, or in other words, you can send a substitute to carry out the work.

In all cases, these contractual rights should be supported by your working arrangements.

How far back can an IR35 investigation go?

HMRC have advised that they’re focussing on making sure that businesses comply with the new IR35 reforms, rather than looking at historic cases (unless they suspect deliberate avoidance of employment taxes or fraud). That said, HMRC are still starting IR35 enquiries and seeking to collect unpaid employment taxes from earlier years.

If you’re in doubt, you should have your current contracts reviewed by an expert to have an independent opinion on your IR35 status. Remember, your status can vary between contracts. If you believe your client has made the wrong decision about your employment status, there is an appeal process that you can follow.

What happens at the end of an enquiry?

If HMRC conclude that your employment records are accurate, then nothing further happens. But, if HMRC determine that your contract is in fact inside IR35, then you’ll have to pay any tax and National Insurance owed. You may also need to pay interest and a penalty. Penalties are based on taxpayer behaviour and penalties can vary, so HMRC will inform you of this amount if necessary.

You do have the right to appeal the decision, but remember that costs can quickly snowball, so it’s best to seek professional advice before taking any further action. After all, you also have to weigh up the time and energy spent away from your business.

How can I protect myself?

Keeping accurate and organised records, submitting your tax returns on time and explaining any changes before the question is asked are just a few ways you can give yourself the best defences.

In addition to following the right procedures, having tax investigation insurance in place can save you precious time and money. Even if you win, the cost of defending yourself in an IR35 enquiry can sometimes skyrocket into the thousands.

“Some tax protection policies, like FSB’s, will even include representation from a former tax inspector, which is invaluable experience to have on your side when dealing with the complexities of IR35 and HMRC,” says Jacqui Mann.

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