What is IR35? And How Do I Handle an HMRC IR35 Investigation?October 12, 2018
Updated: 12/10/2018 According to a report from the BBC, the Treasury intends to use the Autumn Budget to crack down on the 'synthetic self-employed'.
If you are a contractor, freelancer or are otherwise self-employed, it’s likely that you’ve heard the term IR35 bouncing about. And if you haven’t heard of it, here’s a quick refresher of the history.
Some years ago, people realised that if they delivered their services to their employer via their own company rather than as an employee, they could pay significantly less tax. Some people would actually resign from their job on a Friday and start work again on the Monday — only as a contractor and not an employee. Highly-paid employees from the BBC and NHS were probably the most high-profile examples.
HMRC obviously wasn’t too happy about this and introduced a new piece of legislation to combat the practice. That legislation is IR35 and it clarifies the distinction between what’s called a disguised employee and a legitimate contractor.
In this article, I’ll take a more in-depth look at the IR35 legislation, the dreaded IR35 investigation and provide some advice for anyone who is currently being investigated.
What is IR35?
IR35, properly known as Intermediaries Legislation came into force as part of the Finance Act 2000. When you get down to it, IR35 tries to answer one simple question: are you a full-time employee or a legitimate contractor?
The legislation covers a lot of ground and there’s too much to summarise here. If you want to read through the Government’s advice on the subject, see the Off-payroll working through an intermediary guide here.
What's new in the 2018 Autumn Budget?
According to a report from the BBC, Phillip Hammond will use the Autumn Budget to overhaul tax rules and crack down on individuals who claim they are self-employed when really they are full employees. The Treasury believes one-third of people using personal service companies are actually employees and should pay more tax.
The new measures could force the firms who employ contractors to ensure 'off-payroll' contractors stay compliant with IR35. A similar measure in the public sector has already raised £410 million in extra taxes since 2016.
Am I employed or self-employed?
Generally, people use three principles to test the employment status of a contractor. The three ‘tests of employment’ are:
- Control: This test covers the degree of control the client (employer) holds over the contractor’s (employee) work and covers things like what, how, when and where the contractor performs the work. A high degree of control indicates an employee-employer relationship and a low degree of control indicates a client-contractor relationship.
- Substitution: This test looks at who does the work. Specifically, does the contractor have to personally deliver the work or can they send a substitute? If the contractor cannot send a substitute, this indicates an employer-employee relationship and if they can it indicates a client-contractor relationship.
- Mutuality of obligation: The final test looks at the offer of work and the acceptance of work. Where there is mutuality of obligation, the client is obligated to offer work to the contractor and the contractor is obligated to accept it. A high level of mutuality of obligation indicates an employer-employee relationship and a low level indicates a client-contractor relationship.
While this isn’t an exhaustive list of tests, it should give you an indication one way or the other. However, if you are concerned about your employment status, I strongly advise you contact a specialist accountant.
Since the legislation came into force, many large organisations have actually played it safe and moved back to having employees rather than contractors. The BBC is probably the highest profile example of this as it has several of its biggest names to revert back to being employees rather than contractors. I imagine this is especially frustrating for those employees since it was originally the BBC that insisted they offered their services through a limited company in the first place!
Unfortunately, HMRC is still pursuing individuals for historic tax debts, including the BBC's Christa Ackroyd who recently lost her appeal over a £400,000 tax bill. A UK tax tribunal ruled that Ackroyd's contract between 2006/07 and 2012/13 should have been subject to IR35 legislation and, therefore, she must pay tax for that period.
Who is at risk?
At 180 Advisory Solutions, we have advised several consultants and other NHS professionals who had previously provided their services to the Health Service via a limited company.
While these individuals weren’t yet subject to an IR35 investigation, the NHS had recently altered its policy to require them to operate as employees.
During our work with these individuals, we found that many of these medically skilled and high-earning had fallen behind on their tax record-keeping and payments and actually required insolvency advice!
This demonstrates that IR35 investigations are hardly the only risk for those providing their services through a limited company.
What is an IR35 investigation?
An IR35 investigation is typically triggered one of three ways. One, you work in a particularly high-risk sector. Two, HMRC’s Transparent Benchmarking team has singled you out. Or three, you have exhibited enough high-risk behaviour to have attracted HMRC’s attention.
All IR35 investigations follow the same basic process and it goes as follows.
- The Initial Letter. If you are selected for investigation, you will receive a letter from HMRC that asks why you consider yourself outside the IR35 legislation. If you have tax enquiry insurance, this is where it comes in handy as even the most IR35 savvy contractor can make a costly mistake that a specialist would not. At this point, you or your representative draft a response to the question and send it to HMRC. If HMRC accepts your response, that’s the investigation over. However, it’s more likely that they will want to dig deeper.
- The Debate. If HMRC doesn’t buy your story, you enter a protracted stage investigation. During this stage, HMRC will investigate your written contracts, your paperwork, your client and, finally, you.
- The Conclusion. Once HMRC has exhausted every avenue of investigation, they will make a final decision on your employment status. If they decide you are outside the IR35 legislation, you can continue as normal. However, if they determine you are inside IR35, they will demand retrospective taxes plus interest and (possibly) penalties. This sum can be substantial if you have been illegitimately working for as a contractor for several years. Once HMRC makes their demand for payment, you have 30 days to appeal the decision. During this 30-day period, you also have the option of HMRC’s Alternative Dispute Resolution process.
As with most things, it pays to have an expert on your side throughout. So even if you do not have tax enquiry cover, you should consider appointing a suitably experienced and qualified professional to assist you.
What should I do if I am being investigated?
If you are being investigated by HMRC, don’t panic. HMRC conducts about 250 new IR35 tax investigations per year and many result in no action being taken.
However, it is essential you take the proper advice so you know what to expect during the investigation.
In this section, I’ve collected some general advice for contractors under IR35 investigation.
- Contact your accountant and insurance provider. As soon as you know HMRC intends to investigate your business, contact the people who are experienced in dealing with them — your accountant and (if you have such cover in place) your tax enquiry investigation insurance provider. Generally speaking, it is not a good idea to try and manage an IR35 investigation yourself as it’s easy to make a costly mistake.
- Save all correspondence and stay organised. As with all dealings with HMRC, it pays to be prepared and organised. Save all correspondence you receive and keep a record of everything you send out. Additionally, make sure all your written contracts, arrangement forms, client communication and so on is up-to-date and easily accessible.
- Keep your answers honest and helpful. When dealing with a HMRC investigation, it always pays to be honest with your answers and information. Being disruptive, dishonest or obstructive will likely make the situation worse and antagonise both sides.
- Seek professional insolvency advice. If HMRC decides that you have been operating inside IR35 and demands a significant payment, you may struggle to pay it back. If this happens, it is essential that you contact an insolvency firm like 180 Advisory Solutions quickly. Insolvency practitioners are experienced in dealing with HMRC and will be able to negotiate on your behalf to secure the best possible outcome.
If HMRC or another creditor is demanding payment of a significant sum and you are struggling to pay it, contact our team for free initial advice.