Every contractor fears it, but for the unlucky ones there comes a day when the post arrives and within it is a letter from HMRC. Very rarely is HMRC correspondence good news, so opening the letter and finding out that you are opening an investigation into your IR35 status is the news that every contractor fears and makes your heart sink.
The initial feeling will be one of guilt, as if you have done something wrong and that this could be the start of the end of your contracting career. However, for those that have genuinely done nothing wrong, believe themselves to be compliant, operate outside IR35, can evidence such, and ideally have an IR35 Tax Investigation insurance in place, there is nothing to fear.
But I haven’t done anything wrong
HMRC is committed to 250 new IR35 enquires each tax year and can essentially open an investigation into anyone, but they tend to base doing so on a risk assessment, and often on cases that they think will generate the largest revenue for efforts put in – common business sense for an organisation that has limited resources. However, HMRC has a secret weapon… a computer system called ‘Connect’. Connect is rumoured to have been developed over many years and cost over £100m, with its purpose to gather a mammoth amount of data from various government and corporate sources, comparing this data to what is submitted on tax returns, and flagging up potential anomalies.
Wherever a computer flags up potential anomalies, there is room for error, and wherever a human does so, there is room for subjectively as well as error – put both together and there is nothing to say you have done anything wrong. But be under no illusion, believing that you don’t earn enough or don’t pose a threat doesn’t exclude you from enquiry – you can still be on HMRC’s radar.
Why not let my accountant or myself defend it?
When the dreaded HMRC letter arrives, the stages an investigation will go through won’t be listed as HRMC give little to nothing away, except for confirming what they are looking into, what they require from you and your accountant (who will also get copies of the correspondence) and when they need it by. They won’t give details on what they do or don’t suspect, so this is where having professional representation appointed to defend you is key. IR35 Tax Investigation insurances like ours will appoint specialists to defend you, experts in their field who are often ex HMRC inspectors and who have also worked in private practice, giving you the best possible chance of a successful outcome. With them on your side, this puts HMRC on the back foot from the off, as they will know the process, upcoming line of questioning and how best to respond. A general accountant may not be familiar with employment status matters and how best to deal with an IR35 enquiry as they don’t do this on a regular basis, experts do. If you chose to go it alone then be warned, HMRC can be very aggressive and will look to seize the advantage where this is the case, especially if the matter progresses to a tax tribunal.
How long will it take?
This is the million-dollar question – a year is never a bad guess, some take far less, whilst a lot take many years with IR35 being such a grey area. The stress of this hanging over anyone is not nice, making it an uncomfortable time, and one that can affect both your working and private life. It also hinders future company budget planning, with key business decisions often put on hold, such as investment in new equipment. However, having an expert defend you gives you the best chance of minimising the time taken to bring about a successful conclusion to the investigation.
The Investigation Process
So, what stages are involved in a HMRC investigation? HMRC often go through a number of stages, although it is rare for cases to progress as far as the Tax Tribunals and higher courts. The stages are:
- Initial notification
- Initial response
- HMRC request meeting to establish working practices
- End client contact
- Initial decision
- Challenging the decision
- HMRC issue warning letter
- Regulation 80 tax assessments and Section 8 NIC decision
- Request review of HMRC decision
- Option to apply for ADR and/or appeal to tribunal
- Escalation to First Tier Tax tribunal
- Escalation to higher courts
- The final decision
HMRC will inform you of what they are looking into and what they want, via what is known as ‘Schedule 36 Powers’. This allows HMRC to see your information, books and records, and which will likely include the following:
- A copy of all contracts
- A copy of company accounts
- Details of expenses, especially travel and subsistence
- End client contact info
- Details of the agencies used to source and land contracts
- Details of the end clients worked for
- Descriptions of the services provided
- Your opinion as to if IR35 applies or not and your reasons for that decision.
- Any supporting evidence you wish to put forward
All of the above will be for a specified time period, and will be required by a set deadline clearly stated within HMRC’s correspondence.
The response to HMRC is a crucial stage in the process. If you have been proactive, you will have risk managed down any HMRC investigation by having your contract(s) reviewed, your working practices assessed and ideally have a confirmation of arrangements documents in place with the end client(s).
If you don’t have a relevant insurance in place, there are specialists who are available and who usually charge by the hour to defend you – but select wisely and look for someone with experience and evidence of being able to deal with these matters.
HMRC request meeting to establish working practices
HMRC will review everything that you have sent them. If they are not satisfied, will require further information to establish your working practices. To do this, they will likely request a meeting with you. It is your right as a taxpayer however to decline such an invitation and continue the enquiry via correspondence. In this case HMRC will issue you with a working practices questionnaire containing around 50 questions.
End client contact
HMRC will often want to contact the end client where your services were provided. Often a matter can rest on the evidence presented by the end client. You should ensure that your defence representation liaise with the client to ensure they are aware of the situation. While HMRC will have a preference to meet your client face to face or by teleconference, it is crucial to be aware that contact may be done in writing. Where this is the case, the letter may fall to the wrong person i.e. the Human Resource Department.
When this happens, it can be very dangerous, as that person or department will have little to no idea about what to do and how to respond, and more importantly, will have even less of an idea about your relationship with your end client representative when you provided services there. This may mean that if they respond directly to HMRC, it can be full of inaccurate evidence as well as undermining the defence case being worked on by your representation.
During the interim period when HMRC are trying to establish contact with end client, you and your defence representative should take time to contact your end client to offer assistance. It must be emphasised that the idea of you and/or your representation assisting with the correspondence rather than the end client is not in any way to alter the evidence, but to ensure that they are clear on how to deal with HMRC and their line of questioning, and to ensure the pertinent and clear facts are presented and reinforced to HMRC.
After the evidence is presented and reviewed by HMRC, an IR35 status decision will be made. If HMRC deem you to be outside IR35, they will close the enquiry and your company will not owe anything. If HMRC deem you to be inside IR35, they will raise an assessment for the tax and NIC’s they believe that your limited company owes. HMRC may also add interest, and a possible penalty if the avoidance was deemed careless or deliberate.
Challenging the decision
This is your opportunity to take issue with any of the Status Inspector’s conclusions he or she has made in respect of the employment status factors. Invariably, the Inspector will take up a juxtaposition. You will therfore need to support your contentions with good, relevant case law, wherever possible.
HMRC issue Warning Letter
If HMRC are not persuaded by your arguments they will issue a Warning Letter. This informs you that they are about to issue tax and NIC assessments. Accompanying the letter will be their deemed payment calculation.
Regulation 80 tax assessments and Section 8 NIC decision
These are issued soon after the Warning Letter and upon receipt of them you must lodge an appeal. This is done together with any application to postpone all or part of the tax and NIC, with HMRC within 30 days of issue, unless you do not intend to contest them.
Request review of HMRC decision
It is worth at this point requesting an internal review of the decision made. This will be conducted by an inspector who has had no dealing with the initial enquiry. They will either uphold the original decision or overturn it, depending on the findings of their review.
Appealing the initial decision
You have 30 days in which to appeal the decision made by HMRC, requesting that the matter be escalated to the First Tier Tax Tribunal. However, to get a fixed date for hearing can often takes months. During this interim period, you have the option to use HMRC’s Alternative Dispute Resolution (ADR) process. This is something which has had varied success amongst contractors. It sees an impartial facilitator from HMRC who has had nothing to do with the case bring the two parties together in a meeting. This is done in an attempt to find common ground and resolve the issue. Taking this route has no detrimental effect on you so it is certainly an avenue worth exploring. It saves the time and costs associated with taking matters to the First Tier Tax Tribunal.
Escalation to Firs Tier Tax tribunal
If the ADR process is sought and is unsuccessful, or is not explored, and no further evidence is presented, the matter can be heard by the First Tier Tax Tribunal. HMRC and your representative will both prepare evidence. During this they will bring witnesses forward and make their case to the judge. HMRC will likely to have switched inspector to someone from HMRC solicitor’s office or even legal counsel. After hearing cases from both sides, the judge will retire to consider matters. The judge will then issue a ruling, which is often months later. This will be based on the evidence presented and heard at the Tribunal. Both you and HMRC can appeal this ruling if they wish, taking the matter to the Upper Tax Tribunal. However, this can only be on a point of law, otherwise it must be heard in the higher courts. This process is virtually identical to the First Tier Tax Tribunal.
Escalation to higher courts
There are very few matters which will reach this point, but the occasional case does require escalation to higher courts. Decisions made here often set legal precedent, take a long time and cost a lot. However, as with every fair legal system, they ensure an independent and just outcome.
The final decision
Ultimately HMRC will find you inside or outside IR35. Where you are found to be outside IR35, HRMC will not usually appeal. This means the investigation is over, the assessments are reduced to zero, and nothing is owed to HMRC. Only in three limited circumstances can the tax tribunal award costs.
Where you are found to be inside IR35, the limited company will owe arrears of income tax, NICs, interest and possible penalty minus Corporation Tax relief for the deemed payment. By this stage HMRC, will not consider or entertain settling. As a result the amounts are due in full, something which can financially cripple a company.
Conclusion – how do I best protect myself?
So, there you have it. Every contractor who has been through an investigation knows what a long winded, costly, distracting and stressful process it is. To best protect yourself simply follow these simple steps:
- Ensure you get your contracts reviewed by an IR35 expert
- Get your working practices assessed – these trump the terms of the actual written contract
- Take out an IR35 insurance that covers for your representation, and ideally the liabilities
- Take time to understand the basics of IR35
- Don’t fudge the system, it will catch up with you eventually