IR35 ​Investigations Guide

An IR35 enquiry will begin with a letter from HMRC. In the past, these letters have often been dressed up as an employer compliance review about payroll, or perhaps as a request to confirm or clarify a fact on a contractor’s tax paperwork, but now these letters are often more direct.

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Below is an extract from a typical first letter to the contractor (visit the IR35 Resources section for a full example letter):

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"Will you please tell me whether you have considered the possibility of the company being subject to what is commonly referred to as the IR35 legislation? If you have and have concluded that the company is not subject to that legislation then please explain to me the basis upon which you arrived at that conclusion. I am asking this to help me be fully aware of and understand any view you may hold on the application of the IR35 legislation."

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HMRC are able to request information relating to a contractor’s past, present, and future using ‘Schedule 36 Powers’. It is therefore likely that a letter will also request documentation such as copies of contracts to use as evidence.

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It is not 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. 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. Read a real life example here.

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The IR35 specialist will work with the contractor to collate evidence of their IR35 status to present to HMRC. These will often include any contracts relevant to the enquiry period, ideally the contractor will have already had a contract review but if not, this can be done by the IR35 advisor along with a review of the working practices. Having a Confirmation of Arrangements (COA) letter signed by both the contractor and the end client to confirm the working relationship is also a great piece of evidence to have.

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Contractors representing themselves can be faced with a prolonged investigation and at times end up with a significantly higher tax and NI bill, than if they were in receipt of professional representation. An IR35 expert will look to ease the burden on you, correspond with HMRC on your behalf and try and cut short an IR35 review from the outset.

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Contractors who have an IR35 Insurance policy should contact their provider before taking any action. This is usually a requirement of the insurer and failure to do so could result in the policy being invalid. The insurer will then appoint an IR35 specialist to fight the case from the start. If you do not 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.

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HMRC will want to talk to the end client should they find that in their view, the evidence the contractor has provided to be insufficient.

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It is certainly advisable for the contractor and the specialist to meet with the end client(s) to get them onside before this happens. This is essential, as a contractor’s defence may stand or fall on the client’s evidence.

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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 who may have little idea of the nature of the contractor’s relationship with the project manager, making a meeting all that more important to ensure the appropriate person deals with any such correspondence.

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HMRC will often request to meet with the end client, who does have the right to refuse such a meeting but may be unaware that this is the case, so the typical reaction is to agree to a meeting. It is also extremely important that when providing HMRC with contact details at the end client that the details given are those for someone who is fully aware of your day-to-day working practices.

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The reason for the IR35 specialist and contractor to meet with the end client is not to tamper with evidence in any way, but to ensure that the client understands how to deal with questions and requests from HMRC.

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Once all avenues have been exhausted, the time will come for a decision on the contractor’s status to be made.

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The contractor will either be found to be inside or outside of IR35.

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If found to be outside of the legislation, the enquiry will close in the contractor’s favour.

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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.

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HMRC will issue two assessments for the enquiry period:

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• Unpaid Pay As You Earn (PAYE) Income tax determined under regulation 80
• Unpaid NICs determined under Section 8

There is the potential for a penalty to be added should the inspector decide that the avoidance of paying the correct tax was due to behaviour that was careless or deliberate on the contractor's part.

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At this stage, a contractor’s advisor would appeal against both of these assessments and request that all additional liabilities be postponed until the investigation is settled.

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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.

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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 both HMRC and the contractor and their adviser present their case in person to a facilitator- another HMRC inspector who has had no involvement in the case until this point, in the hope of reaching an agreeable outcome thereby avoiding the need to go to a tax tribunal.

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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.

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In the event of an unsuccessful ADR and no further evidence coming to light, the case will be heard before the first tier tax tribunal. The process at this stage is relatively straightforward.

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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.

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Either can introduce witnesses to provide and support evidence, whom the judge can question.

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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.

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In extreme cases, the case may proceed to a higher court.

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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.

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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.

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The calculation of the final assessment is based on the ‘deemed payment’ the contractor would have earned during the contracts caught by IR35, minus a corporation tax deduction for the period in question.