The IR35 investigation process
Are you a contractor who has received a letter from HMRC which says they’re investigating your IR35 status?
For work carried out prior to April 2021, HMRC still issue communication to the contractor themselves in relation to their IR35 status.
Don’t panic. This is something that has happened to plenty of contractors since IR35 was introduced back in 2000 and isn’t usually cause for alarm.
If you believe that your IR35 status prior to April 2021 was compliant, take a deep breath. We’re here to help you understand what an IR35 investigation is and what to do next.
Why have I received this letter?
HMRC have various systems in place to flag up contractors who they believe might be wrongly operating inside IR35.
HMRC base their flagging system on a number of factors, from your annual turnover to anomalies on your tax returns.
However, these checks could return your business’s details in error, so just because you are the subject of an investigation doesn’t mean HMRC will accuse you of avoiding tax.
What is IR35?
IR35 was designed to stop off-payroll workers (e.g. contractors) from avoiding paying income tax and National Insurance (NI) contributions. IR35 has been around for a while in the UK, but it was reformed in 2021 to stop private sector contractors from being able to self-declare their IR35 status.
Before the IR35 reform came into force, HMRC felt that contractors were at risk of acting as ‘disguised employees’ and not paying the right amount of tax and NI due to not being taxed at source via Pay As You Earn (PAYE) like on-payroll workers are.
Now, the hiring company is responsible for determining the IR35 status of the people they hire. If HMRC disagrees with their view, they can be fined, leading to tension between firms and contractors.
The IR35 investigation process
So, you’ve received a letter from HMRC – what next? The letter itself might not give you any clues, as HMRC prefer to operate on a need-to-know basis to avoid giving too much away should they need to try to prove that IR35 applies in your case.
Luckily, there are quite a few stages between the initial letter and a tax tribunal (and it’s unlikely to ever get there). These stages include:
1. Initial letter
This is the first letter you’ll receive from HMRC out of the blue, asking for things like:
- Copies of contracts and company accounts
- Expenses information
- Details of your end clients
- An explanation as to your current IR35 status
You should gather this information without delay.
2. Your response
This is the letter you’ll send back to HMRC along with the information they’ve asked for. You should do this by the deadline on the letter – if you think you’ll struggle to meet this, then you can get an extension by contacting the officer dealing with your case.
3. HMRC’s response
This might be where it ends, and HMRC may decide you are operating outside IR35 based on the information you provide alone.
However, if HMRC wants to know more, this is the stage when they’ll request a meeting to find out more about your working practices. You don’t have to agree to this – you can carry on the investigation by letter if you’d rather.
Whether you agree to a meeting or carry in via letter, HMRC will ask you some questions to learn more about the way you work.
4. HMRC contacts the end client
Here, HMRC will contact one or more of your end clients using the contact information you provided at stage 2.
This is a delicate stage, as you have no control over the accuracy of the information your end client provides to HMRC. In an ideal world, you will have explained the situation to your end client in advance, so they understand the importance of giving the correct picture of the nature of your work.
5. HMRC decision
After considering your responses to the questions asked at stage 3 and the information provided by your end client at stage 4, HMRC will decide your IR35 status. They will close the investigation if they believe that you are operating outside IR35.
If they believe you are within IR35, they will send you a bill for the tax and NI they think your company owes. In some cases, a penalty is included – such as if they have good reason to believe you deliberately misled them or avoided tax.
6. Challenge the decision
If you don’t agree with HMRC’s decision, it is your right to challenge them at this stage. Having a partner on hand who is well-versed in IR35 reform is highly recommended, as you’ll need to back up your reasons for appeal with the right laws and case examples.
7. HMRC warning letter
If HMRC disagrees with your appeal grounds, they’ll send you a letter warning that they will send tax and NI assessments and calculations soon.
8. Tax and NI assessments
Soon after the warning letter at stage 7, HMRC will send their calculation for the tax and NI they believe you owe. You can officially appeal the decision at this stage – you have 30 days to do this.
9. Escalation and mediation
Your appeal will be escalated to HMRC’s Alternative Dispute Resolution (ADR) at this stage. This is an impartial third party from HMRC who will try to reach a resolution between you and HMRC before it reaches First Tier Tax Tribunal stage.
10. First Tier Tax Tribunal
If you end up here, it means that you and HMRC have completely different opinions on your IR35 status. You should seek expert representation to help fight your corner and enable you to prove that you’re working outside the legislation.
The tribunal will be in front of a judge, who will make a ruling based on what they hear and the evidence presented.
11. Higher courts escalation
This is rare, but in some cases, contractors have to go to the higher courts to seek a decision. If at this stage, the contractor is found to be inside IR35, they will be liable for all unpaid tax, NI contributions and usually fees and penalties, too.
As we mentioned, it’s rare for a contractor’s case to reach this stage. But it’s a good example of why you need an experienced expert on your side to defend you.
This article was written by QAccounting, who offer accountancy and bookkeeping services to freelancers and contractors across the UK.
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