IR35 enquiry: what contractors need to know
Not to be outdone by the taxman -- who last month updated his IR35 guidance -- we too are issuing two new advice pieces to ContractorUK on enquiries under the rule; what they mean for contractors and how they can handle them, writes Rebecca Walker of Abbey Tax Protection.
How an IR35 enquiry starts
Since the introduction of HMRC’s new approach to IR35 in May 2012, the tax authority has been seeking to test a contractor’s IR35 status by issuing ‘Check of Employer Records’ letters. These letters are issued by one of the four specialist offices in Edinburgh, Salford, Bradford and Croydon. A typical letter will state the following:
"Every year we check the records of a number of businesses to make sure they are correct and complete and that the business is paying the right amount of tax and National Insurance Contributions (NIC). We have now selected your business for a check. I confirm that this is not an enquiry into your Corporation Tax Return.”
The letter will then ask the contractor to:
- provide a breakdown of the income for a particular year – this can be the PSC’s accounting period or more commonly now the last full tax year
- provide copies of all of the contracts and documentation relevant to the contracts that gave rise to the income during the specific year
- on occasions, answer queries relating to expenses and benefits
Then comes the key paragraph:
“Will you please also 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 for this to help me be fully aware of and understand any view you may hold on the application of the IR35 legislation.”
This almost reads like an essay question, but the importance of a strong answer cannot be underestimated. Our personnel takes care to understand the full detail of the working practices, the contractor’s business practices and any other relevant information that we believe adds credence to the contractor’s argument. The one issue, rarely considered, unless there is good reason, is the Business Entity Tests (see part two of this guide) because they very rarely point to any other position than medium or high risk of IR35 applying.
Why you should politely refuse to meet HMRC
HMRC are also keen to have a face-to-face meeting (although that is their standard position for any type of enquiry) in the belief that the enquiry can usually be concluded more quickly and efficiently.
Unfortunately, our concern is that a meeting is not necessarily best for the contractor. A meeting agenda and list of questions are not automatically issued beforehand, so the contractor is expected to answer ‘off the cuff’ without having had the benefit of time to consider the questions beforehand. Furthermore, notes of these meetings are not verbatim and the possibility of misinterpretation and misunderstanding, particularly given the complexities of the legislation, is rife.
By contrast, asking HMRC to put their queries in writing ensures there is a full audit trail and the opportunity for the contractor to give considered responses. There is a duty on the contractor to provide the information reasonably requested by HMRC and contractors should be aware that HMRC can use legislative powers and issue a Section 36 Notice (see part two of this guide) to obtain information if a response is not forthcoming.
All contractors should be aware that they are under no obligation to meet with HMRC.
If the contractor responds with enough evidence to satisfy HMRC that the contracts are not caught by the IR35 legislation, HMRC will, following a review of the information and documentation provided, close the enquiry. If, however, HMRC considers there is insufficient information from which to make a decision, a further letter will be issued asking for a face-to-face meeting. The invitation to a meeting should be politely declined which results in a list of questions for the contractor to consider and respond to. What is usually lacking is any sort of meaningful explanation as to why the initial information was insufficient to conclude matters!
The taxman’s tactics
HMRC officers are typically very vague and will simply say they need more information. Given that the HMRC officers are tasked with considering the information provided at every stage of a review, arguably the officers should have formed, as we at Abbey Tax will have done, a view about the strengths and weaknesses of the cases in question.
As our team are increasingly finding of late, HMRC is seeking to obtain more information not only from the contractor, but also from third parties such as the agency (if one is involved) and specifically the end-client. In fact, a number of IR35 successes for HMRC have come from making contact with the engaging organisation – the cases of Island Consultants and Dragonfly Consultancy for example – and comments made to the Revenue by managers at the end-client outfit have been instrumental in helping HMRC to prove its argument.
The sad reality is that HMRC is far more inclined to trust the comments made by the end-client, than those provided by the contractor. Where HMRC has obtained information, it is vitally important that this is scrutinised by the contractor for any errors or inaccuracies, and comes from someone within the organisation who can honestly comment upon the situation between the parties. It is important to challenge the value of any generic information provided by end-client personnel who did not have contact with you, the contractor.
Issuing an opinion
Once HMRC decides that it has obtained sufficient information in relation to the contract(s), an opinion will be formed and issued. If the contractor disagrees with this opinion, the contractor has the right to object and explain why. This may then entail HMRC seeking further clarification before reinforcing the view that IR35 applies or amending it to confirm the enquiry is at an end.
If the outcome is that IR35 applies, then formal notices will be issued, against which there is a right of appeal. If HMRC does not agree with the contractor’s objections contained within the appeal against the notice, a formal decision will be issued. A structured process begins leading towards a possible hearing at the First-tier Tribunal.
Appealing HMRC’s decision
The contractor can appeal directly to the First-tier Tribunal, or ask for their case to be considered by HMRC’s Appeals and Review unit. Whilst not exactly independent, the reviewer will be someone unconnected with the case and who has not had any involvement in the case to date. This is known as the Internal Review procedure and is available for any tax or VAT case, not just an IR35 related matter.
As the procedure is undertaken by another member of HMRC, clearly it is not entirely independent and there is an obvious concern about possible bias in the conclusions formed. Nevertheless, it should still be considered because it is the contractor’s chance to not only repeat the technical merits of the argument, it is also the opportunity to highlight any poor handling of the case by HMRC. It might influence HMRC’s decision whether to go to Tribunal because at this stage of the review, a cost and benefits consideration comes into play as a direct requirement of HMRC’s litigation and settlements strategy.
If the Reviews and Appeals unit conclude that IR35 applies but the contractor does not agree, an appeal can still be made to the Tax Tribunal. A contractor should not necessarily fear going to Tribunal if there are solid grounds to do so, but without the benefit of some form of tax investigations insurance, it is understandable that a contractor may wish to consider the commercial reality of taking this course of action. There is still an element of uncertainty after all.
If a contractor is found to be within IR35 following an enquiry, the tax and NICs due must be paid to HMRC by the contractor, as well as any interest due on these amounts.
If the circumstances of the contractor’s case show that reasonable care was not taken in completing tax and NIC returns (including the business/company’s final end of year tax and NICs return), a penalty may be levied.
This will be a percentage of the tax and NICs due, and will be determined based on an assessment of the contractor’s behaviour surrounding the case, including whether any inaccuracies reported to HMRC were deliberate.
We would argue that one example of positive behaviour, would be to undertake a contract review – particularly one which considers both the contractual terms and the working practices. If a contractor has undertaken such a review and this deems the engagement to be ‘not caught by’ or ‘outside of’ IR35; then if the contractor is subsequently investigated and HMRC are successful in classifying the engagement(s) as ‘caught by IR35’, the contractor would have undertaken due diligence and therefore would likely escape a penalty.
Editor’s Note: This is part one of a two-part guide by Abbey Tax Protection on the current IR35 enquiry process. Part two details how to minimise your chances of being investigated under IR35.