IR35 Investigations & Penalties
The UK government enacted legislation in 2000 called IR35. The purpose of this legislation is to prevent contractors from reducing taxes through a limited company while maintaining a permanent working arrangement with an end-hirer.
Our Easy IR35 Guide provides a detailed explanation of IR35 and how your status is determined. You can also read our article explaining IR35 determination that also includes an analysis of HMRC’s CEST Tool for more insights into how the government determines your status.
What triggers an IR35 investigation?
IR35 investigations are triggered from from both direct and indirect factors. While HMRC does not disclose many details of the selection process, there are some factors that affect how frequently they occur that include:
- Specific employment sectors
- Use of HMRC’s contract review service
- HMRC’s special software
- Anonymous tip-offs
Along with these direct triggers, indirect triggers may result from investigations into corporation tax, payroll tax, or VAT.
What happens during an IR35 investigation?
Many contractors do their best to remain compliant. Despite their best efforts, HMRC may initiate investigations into their accounts.
HMRC’s investigations typically start with a request for information regarding a specific time period. Some requested information may include:
- The contractor’s explanation for why IR35 doesn’t apply to their business
- Detailed income breakdowns for specific years
- Copies of all work contracts for the specified years
HMRC may investigate accounts and working relationships for the last 20 years if fraud or tax avoidance is suspected. Enquiries are typically closed if authorities are satisfied with the evidence. If HMRC believes that IR35 applies, they will send another letter requesting an in-person meeting.
An in-person meeting with the HMRC may speed up the enquiry. During the meeting you will have the opportunity to disclose all relevant information, provide documentation and ask questions. Should you choose not to accept the invitation, HMRC will continue the enquiry by sending you Schedule 36 notices. This stage can take several weeks to several years and may result in a request to attend a hearing at a Tax Tribunal.
Factors HMRC considers during an IR35 investigation
Several factors are taken into account when HMRC is conducting an IR35 investigation into your business:
- Professional relationship: Are you an office holder in any company, such as a secretary, treasurer, trustee or company director? Do your contracts permit you to work for industry competitors? Do you have other contracts? How many?
- Substitution: Do you send a substitute to perform the work on your behalf? Is it easy for the end-hirer to replace you with another employee at the company?
- Direction: Are you really your own boss, or does a supervisor direct you and frequently change your required tasks?
- Schedule and location: Do you have to be at the office a set number of days per week at specific hours?
- Employment risk: Do you have to buy equipment, fund vehicle costs, or provide materials before the client pays you?
- Remuneration: Are you paid hourly, weekly, or monthly? Or are you compensated based on a commission or company profits?
- Benefits: Do you get holiday pay, bonuses, or perks like fitness memberships or discounts? Were you invited to the holiday party?
HMRC makes its determination based on your answers to these questions. Accordingly, you may be subjected to significant penalties if you the authorities believe you are “inside” IR35.
How IR35 Penalties are Calculated
The updated penalty regime for IR35 was introduced in April 2009 as part of a new set of rules for errors in tax returns and other documents.
As part of the new framework, contractors with an incorrect employment status that are caught inside IR35 must pay back the following amounts:
- The amount of unpaid tax plus a 30% penalty if HMRC deems that you were unaware, careless or otherwise unwillingly declared an inaccurate employment status
- Unpaid tax plus a 70% penalty if HMRC believes that you were aware of your IR35 status yet decided not to act
- A 100% penalty on the amount of unpaid tax if HMRC decides that you actively intended to conceal your IR35 status and purposely engaged in tax avoidance activities
IR35 Investigation & Penalties FAQ
While HMRC stipulates that enquiries are picked at random, contractors can directly trigger an IR35 investigation. Triggers that can initiate an IR35 investigation include corporation tax audits, payroll tax investigations or VAT audits.
HMRC reserves the right to investigate your contracts, accounts, administration and working practices for the previous 20 years.
Payment penalties are 30% of unpaid tax if HMRC deems that you were unaware of your status. The penalty is 70% if the authorities believe you chose not to act. The highest penalty of 100% is levied if authorities believe that you actively concealed your IR35 status.
If you are investigated and HMRC determines you were unaware of your status, you may be subjected to the minimum penalty of 30% of the tax you owe.
HMRC can take numerous actions to collect the tax you owe. These include garnishing your earnings or pension, employing a debt collection agency, seizing assets, directly deducting from your bank account. HMRC may also take you to court or close your business in extreme cases.
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