Regardless of how IR35 savvy and compliant you believe you are, HMRC can mount an
enquiry into any contractor. If you are trading as ‘outside’ IR35 and taking dividends,
there’s nothing you can do to prevent an IR35 enquiry.
Obviously if you are genuinely in a strong position and have taken steps to ensure you are compliant you will stand a good chance of winning your case, but IR35 investigations are rarely simple affairs.
It isn’t advisable for a contractor to handle an investigation without the guidance of a specialist; even the most IR35 savvy of contractors are not prepared for HMRC’s tactics and are often unaware of the powers HMRC hold.
Contractors who have an IR35/Tax Enquiry Insurance policy should contact their provider before taking any action. The insurer will then appoint an IR35 specialist to fight the case from the start. If you don’t hold an appropriate policy, you can still seek the help of a specialist but will most likely have to pay hourly consultancy fees, which can soon mount up to thousands of pounds - a lot more than the cost of an insurance policy.
HMRC will select either a tax year(s) or accounting period(s) for enquiry, bearing in mind that they can only go back 4 years in most cases (6 years for careless behaviour) and will initially ask to see copies of all contracts, analysis of fee income and sometimes certain expenditure, such as travel, for the enquiry period and reasons why the contractor considered that the Intermediaries Legislation did not apply.
The way the investigation is handled from the start is crucial, as a satisfactory response to the initial letter can close down an enquiry right away.
An IR35 expert will look to ease the burden on you, correspond with HMRC and try and cut short an IR35 review from the outset and will work with the contractor to collate evidence of their IR35 status to present to HMRC, backed up by case law.
If HMRC are not persuaded that IR35 is not applicable, they will then request a meeting with the contractor to discuss the day-to-day working practices. The taxpayer is under no obligation to accept such an invitation and may deal with the matter by correspondence should they so wish.
If, after being provided with full details of the working practices, HMRC still cannot form an opinion they will seek to make contact with the end client to corroborate the contractor’s version of events. Although they prefer to meet with the end client, again, just like any other taxpayer’s right, they can choose to answer HMRC’s questions by correspondence or perhaps teleconference.
HMRC’s contact with the end client usually starts via written correspondence. Unfortunately, it is often the case that this falls into the wrong hands, such as human resources departments, that may have little idea of the nature of the contractor’s working relationship with the end client.
After having heard both sides of the story, HMRC then form their IR35 opinion.
If the contractor is found to be inside IR35, the inspector will raise an assessment for the tax and NICs HMRC believe are owed by the contractor’s limited company under the IR35 rules.
There is the potential for a penalty to be added should the inspector decide that the avoidance of paying the correct tax was deliberate.
At this stage, a contractor’s advisor may try to negotiate a settlement with HMRC.
The contractor has 30 days to appeal to the decision and request that the case be taken before the first tier tax tribunal. It can take months for this to happen and the enquiry is not on hold during this time.
During this period, the contractor has the option of HMRC’s Alternative Dispute Resolution (ADR) process, which has proven to be very effective in some cases. This process sees the case reviewed by a facilitator- another HMRC inspector who has had no involvement in the case until this point.
It is worth the contractor trying this route as it has no negative impact on the case and can result in a positive outcome for the contractor in a reasonably fast amount of time, with an average turnaround of 45-90 days depending on the complexity of the case. This process can settle a case without the need to go to a future tribunal, which may have been scheduled.
In the event of an unsuccessful ADR and if no further evidence comes to light, the case will be heard before the first tier tax tribunal. The process at this stage is relatively straightforward.
Both HMRC and the contractor’s advisor will prepare evidence to present to the tribunal judge. HMRC’s representative (usually an inspector specialising in appeal hearings) and the contractor’s advisor make their case to the judge. Either can introduce witnesses to provide and support evidence, whom the judge can question.
It can be months before the judge issues a ruling based on the evidence presented during the tribunal. Both the contractor and HMRC can appeal this decision which will take the case to the upper tax tribunal where the process is repeated, often accompanied by additional evidence or witnesses.
In extreme cases, the case may proceed to a higher court.
If the contractor is found to be outside IR35 and HMRC do not appeal, the investigation is over and the regulation 80 and section 8 assessments are reduced to zero, however it is rare for costs to be awarded.
If the contractor is found to be inside IR35, their limited company will have to pay any unpaid income tax, NICs, interest, and potential penalties. This can be financially crippling for a limited company and it is too late at this stage to try and agree a settlement with HMRC.
During the initial stages of an IR35 enquiry, contractors will be required to present HMRC with evidence of why they consider themselves to be outside of IR35. Should the contractor be able to provide such evidence, then this may be sufficient enough to satisfy HMRC and close an enquiry before it really gets going.
The contract sets out the agreement between the limited company and the Employment Business/End Client and therefore we do stress the importance of having your contract reviewed by an IR35 specialist. This will not only advise you as to your IR35 status but will demonstrate that you have operated due diligence by seeking advice and confirming your status (which can help avoid penalties down the line).
If the contract is deemed to fall outside of IR35 but doesn’t reflect the working reality of the contractor, this could reduce prospects in defending an IR35 enquiry as HMRC would argue that the contractual clauses do not reflect reality and therefore carry no weight. In our experience of dealing with enquiries, the working practices weigh more heavily than the contract itself as this will reflect your actual working relationship with your end client. A working practices review is always advisable alongside a contract review to ensure that your actual working practices are compliant with regards to IR35, and if possible, signed by your end client to demonstrate that they are agreeing to the way in which you are providing your services. This is often presented in the format of a Confirmation of Arrangements letter which should also include the business card of the person who has signed it.
It is also useful to keep as many of the following as possible to prove the existence of different status tests:
Following HMRC's opening letter, the contractor was asked to undertake the Business Entity Tests (which have since been abolished due to their ineffectiveness) for each of the four contracts that fell within the period of enquiry. The result of this was that the contractor only fell into the medium risk category.
The contractor had produced a list of factors that they felt placed their company's relevant engagements outside of IR35. After reviewing this, Qdos presented the contractor with a list of questions relating to various employment status factors.
Once the contractor had responded to the questions put forth, a nine page letter was compiled focusing on the main status factors for each contract that supported the opinion that the contracts were not caught by IR35. This was bolstered by references to relevant case law.
This evidence was sufficient to enable HMRC to agree with Qdos’ opinion at a very early stage of the enquiry, although the fact that the contractor had concurrent contracts was a significant advantage.
It was interesting to see that the client only fell into the ‘medium risk’ category in the Business Entity Test, reiterating the risk that contractors face when relying solely on this form of self-assessment and not taking out additional forms of protection.
1. Contractor not holding TEI/TLC
Enquiries can rumble on for some time, years even, and professional fees can become expensive, even more so if an appeal ends up at Tribunal, resulting in contractors asking for duck tape when they need a welder.
2. Not seeking expert advice from the outset
Some contractors believe they can deal with an enquiry themselves or with their accountants help. When things start to get difficult however, the contractor & their agent invariably turn to specialists like Qdos for assistance by which time some damage may have already been done & the specialist adviser is faced with a degree of ‘firefighting’.
3. Not undertaking IR35 due diligence
If a contractor cannot produce evidence that discharges their obligation to consider IR35, this leaves the door ajar for HMRC to consider penalties should the contract fall inside of IR35.
4. Not maintaining an IR35 dossier
The length of an enquiry can be shortened if a contractor has maintained & retained a dossier relating to their working practices, particularly surrounding the areas of control.
5. Going into a meeting underprepared
Where a contractor has agreed to a meeting with HMRC, I always undertake a mock meeting with the client prior to the actual meeting itself. This prepares the contractor for the type of questions that they will be asked & to coach them in their responses, such as their terminology.
6. Having no control over HMRC’s contact with the end client
In most cases, end clients will not agree to the contractor or their agent being present at any meeting between themselves & HMRC. In these cases, every effort should be made to ensure that HMRC provide the contractor & their representative with an agenda & list of questions to be asked at that meeting. The agent can then, with the assistance of the contractor, offer to provide the end client with assistance in answering such questions, again in the use of terminology & presenting the facts in the best light. On too many occasions, unwitting end client representatives say the wrong things & allow themselves to be ensnared by HMRC’s leading questions.
7. Having a partisan Status Inspector in charge of an enquiry
Inspectors are supposed to be impartial, objective & only interested in ensuring that the correct amount of tax is collected, yet attitudes amongst them vary Maverick Status Inspectors seem to be on their own personal crusade which is blatantly wrong & adopt the attitude for which HMRC were severely in the 2006 Special Commissioners case of Lewis t/a MAL Scaffolding. The Commissioners suggested that in effect HMRC had handled the status enquiry in a less than objective manner. They wanted to establish an employer/employee relationship for their own purposes and then went out to justify a conclusion they sought. These words should not be underestimated:
“HMRC appear to have approached their investigations on the basis that there must be an employment relationship between MAL Scaffolding and the workers there if one looks hard enough. Officers then went looking on that basis and persuaded themselves that they had found that for which they went looking. They have totally failed to persuade me.” These type of Inspectors refuse to listen to reason & interpret the facts to suit their own ends & consequently make it very difficult for the enquiry to be resolved expeditiously. I can name two of them in particular, both in the Salford team – Julian Barkley & Ian Pannett. Two very awkward individuals.
8. Not knowing your taxpayer rights
Do not be scared to enforce them at all times, nor allow HMRC to overstep the legislative boundaries, and do not be afraid to complain about an officer’s behaviour/actions if it is detrimental to the course of the enquiry.
Maximise your chances of success with expert help in a tax enquiry
Reduce the impact of an IR35 enquiry with comprehensive IR35 insurance
A detailed review of your IR35 status in both written terms and working practices.
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