IR35 enquiry: protecting yourself from HMRC
Having spelt out the ins and outs of coming under an IR35 enquiry by HM Revenue & Customs, this article explores how contractors can help to avoid the process altogether and, if they can’t, what they might come up against, writes Rebecca Walker of Abbey Tax Protection.
Dividends and low salary: ensure best-practice
From an income point of view, there is absolutely no legal reason why a personal service company director cannot receive a minimal salary and take the remainder via dividends. Yet it is important to know how this ubiquitous action impacts on HMRC’s risk assessment. Quite simply, it is likely to send the ‘risk’ soaring!
Certainly if dividends are being paid, it is sensible to make sure that the procedures for doing so are fully adhered to, including having a shareholders’ meeting -- at which the dividends are voted and then dividend vouchers properly issued. Even if IR35 is not deemed to apply, it would be frustrating if, instead, the method of remuneration was challenged by HMRC because of procedural matters.
Confirmation of arrangements - drawn up and signed?
As a contractor, take steps to clarify the understanding of the engagement with the end-client because if, at the start of any enquiry, HMRC can be shown a signed letter by the end client as to their understanding of the relationship between the two parties and the working practices of the assignment, providing it confirms that the contractor is independent and able to show that this really is a contract for services, it can be useful in demonstrating that both parties are ‘singing from the same hymn sheet.’ This leaves HMRC less room to develop its arguments. Certainly this has proved successful in the past.
Paperwork is prudent to protect your outside IR35 position
It is important that the contractor considers the marketplace at the end of each contract and it is advisable too, to keep records of all contract negotiations, successful or otherwise. There may have been no need to substitute the contractor’s services, but keep records of any potential substitutes with whom this would be possible to organise. Similarly, maintain details of matters which show financial risk such as contracts which were terminated prematurely, periods without work and financial losses that have been made (e.g. on fixed price work) or times where, perhaps, it has been necessary to undertake remedial work to ensure a project stays on track, or additional hours that were not charged for.
Ensure records are in place, such as mileage logs and expenses payments. Apart from being needed to prove business expenses claimed, they may help prove that the contractor had control over the 'when' and the 'where' because they evidence that work was not always undertaken on-site. The Dragonfly case proved that just having ‘Control’ over 'how' work is performed is not enough.
Consider reaching out to the experts
As mentioned in part one in respect of penalties, consider having engagements reviewed so that both the contractual terms and the working practices are considered against the key factors of Personal Service, Control and Mutuality of Obligations, as well as the secondary issues relating to business-to-business factors and Financial Risk. If your contracts are deemed to be 'outside of IR35', then still consider insurance to cover any potential liability that may arise. Contract reviews and tax losses insurance are extremely worthwhile services that we know give contractors peace of mind.
Ultimately though, and despite your best efforts, an IR35 investigation may not be avoided. However if one does commence, it is imperative to get sound advice and excellent representation; this is not a battle you will enjoy fighting on your own.
The Business Entity Tests: friend or foe?
The Business Entity Tests (BETs) and Example Scenarios, both unveiled by HMRC in 2012, were created to help contractors assess the risk of an IR35 enquiry. The BETs are widely criticised, with the questions and way they are scored being of little help. As HMRC confirms in its latest IR35 guidance, just because a contractor is in the ‘high’ or ‘medium’ risk band does not mean they are inside of IR35, and just because a contractor is in the low risk band does not mean they fall outside of IR35.
HMRC is already consulting with interested parties about the BETs. It is not only evident that the tests simply do not help any of the parties involved, but they have been entirely misused in the public sector as a very blunt tool to establish the status of an individual engagement, which HMRC would be the first to acknowledge was never their intention.
Those ‘Service Company’ questions
There has been much debate over answering the ‘service company’ question and what HMRC will do with the information. The House of Lords’ Select Committee on Personal Service Companies acknowledged that only a small percentage of contractors completed the ‘service company’ questions on the personal tax return and RTI year-end declaration. In response to the Committee’s report, the government confirmed that HMRC will work with stakeholders to undertake a full review of the questions – their form, purpose and clarity – with a view to making any necessary changes.
When HMRC requests information or documents
Schedule 36 of the Finance Act 2008 allows HMRC to give written notices to taxpayers ("taxpayer notice") or third parties ("third party notice") requesting information and/or documents which are reasonably required for the purpose of "checking the taxpayer's position". Information can be requested in advance of any return being submitted -- a big change for both income tax and corporation tax, not least because the data must be supplied to HMRC within a "reasonable time" as specified in the notice.
HMRC do not need prior consent from either the First-tier or Upper-tier Tribunals to issue taxpayer notices, although there are appeal procedures. But be aware that no taxpayer notice can be given in respect of a period where the taxpayer has submitted a return, unless: that return is under enquiry; HMRC suspect that insufficient tax has been charged; or it is required for checking the taxpayer's VAT or PAYE position.
It is important that you make immediate contact with your accountant if you receive such a notice.
These are different to taxpayer notices in that HMRC must have the permission of either the taxpayer or the First-tier Tribunal before they can issue a third party notice and a copy of such a notice must be sent to the taxpayer. Where the Tribunal agrees to the issue of the Notice (and the taxpayer is not allowed to be present to argue against its issue), the Notice cannot be appealed.
How to appeal against Information Notices
Appeals against taxpayer and third party notices are to be made to the First-tier Tribunal in writing and within 30 days of the date the notice was given and must state the grounds for the appeal. However, where the information or documents form part of the statutory records, then again, no appeal is possible.
HMRC penalties and how to fight them
There is a standard £300 penalty for failure to comply with an information notice or for obstructing an officer of HMRC, unless there is a ‘reasonable excuse.’ Penalties of up to £60 per day (daily default penalty) can also be charged for continued failure after the standard penalty has been issued. In addition, HMRC can apply to the Upper Tribunal for a tax-geared penalty to be imposed for continued failure to comply with an information request. The Upper Tribunal will determine the amount of any such penalty.
Penalties must be issued within 12 months of the date to which the failure relates and these can be appealed against by the contractor giving notice in writing within 30 days of the date of issue. Again, reasons for the appeal must be given.
A taxman on your doorstep?
HMRC will have the power to enter business premises and inspect the premises and business assets and records kept there, where the inspection is reasonably required for checking the tax position. HMRC cannot enter premises that are solely used as dwelling houses. If for example, a contractor keeps records at home, HMRC will be able to enter the premises and view that part of the contractor's home where the records are kept. HMRC should give the occupier of the premises 7 days’ notice of the inspection, but it does not have to be in writing. However, they also have the power to show up unannounced.
Editor’s Note: This is the final part of a two-part guide by Abbey Tax Protection on HMRC’s IR35 enquiry process. You can read part one here, detailing how an IR35 investigation begins.