Back to its old tricks? HMRC reverts to PAYE compliance checks, the original IR35 enquiry route

A lot has been made about HMRC’s plan for policing IR35 compliance following the introduction of off payroll reform in the private sector earlier this year.

And here at Qdos in my role as Head of Tax, I often find myself fielding questions from contractors, who want to know if the legislation still poses a risk to them, given that in all but one scenario it will be the client or agency -- rather than the contractor -- who pays the price for non-compliance, writes Qdos’ Nigel Nordone.

My response is always the same -- DON’T RULE ANYTHING OUT. While the arrival of IR35 reform has seen the liability transfer from contractors to fee-payers, that’s not to say that PSCs cannot and will not be investigated by HMRC which, I can tell you from having worked there, may well have a number of tricks up its sleeve.

PAYE checks were once a pre-cursor to an IR35 investigations

We have recently seen evidence of ways HMRC may look to investigate contractors going forward without breaking its pre-IR35 reform promise, which was not to launch IR35 enquiries against PSCs unless deliberate foul play is suspected.

This is through a PAYE compliance check, which two contractors supported by us currently find themselves at the centre of. In years gone by -- a decade or so ago -- HMRC would regularly carry out these checks to make sure that contractors were meeting their obligations as an employer, despite the fact that the PSC -- as an owner/director -- would be the only employee of the business.

By checking payroll -- and therefore the amount of PAYE tax paid by a contractor -- HMRC will become aware of how a contractor is remunerating themselves. Is it via salary entirely? Or a combination of salary and dividends? This could then give HMRC cause to open an IR35 enquiry as part of this PAYE compliance check.

Granted, it’s a roundabout way of carrying out IR35 investigations, but it was an approach that was often used by the tax office until it stopped abruptly some time ago.

HMRC would not technically have broken any promises

Now, I should stress here that as things stand, the two contractors who received these letters from the taxman are not subject to IR35 investigations, yet. And in truth, things may never progress to that stage -- we certainly hope not anyway. However, given HMRC’s past behaviour, contractors cannot rule this out.

But as briefly touched on, if either were to, technically HMRC wouldn’t have gone against its word, which was to not open investigations unless there is reason to believe fraud or criminal behaviour has taken place.

This is because, as far as HMRC would be concerned, the reason for the investigation was to check payroll compliance, not IR35 -- and the check is independent of any reform-related determinations from the contractor’s client.

Ultimately, that this PAYE check evolved into an IR35 investigation wouldn’t be of much worry to the tax office, I would imagine.

The IR35 risk remains, despite reform

So why does this matter? Prior to April 6th 2021 and the roll out of IR35 changes in the private sector, contractors carried the risk when engaged by medium and large businesses. As they did in the public sector also, before April 6th 2017.

Any PAYE compliance checks that scrutinise payroll compliance retrospectively (back to a time when contractors held the IR35 liability) and evolve into IR35 investigations -- as was once commonplace -- would see the PSC at risk.

My point is that contractors should firstly be aware that HMRC has started policing payroll compliance among contractors, potentially as a ‘way in’ to investigating IR35 arrangements. With this in mind, all correspondence received by contractors should be handled with care and on the basis that it could lead to an IR35 enquiry.

HMRC issues questionnaires and demands interviews

The letter sent by HMRC to those enquired into will set the scene for a seemingly innocuous check or a request to confirm or clarify facts about payroll.

However, in the past these have been anything but innocent and as part of the process, the Revenue tends to issue a payroll and benefits questionnaire, insisting that it must be completed before a telephone interview.

This gentle then heavy-handed approach is typical of HMRC, but it’s important to make clear that contractors are under no obligation to take part in an interview -- you can refuse. Meanwhile, all questionnaires should be completed with careful thought, given information provided to HMRC will be used as evidence.

So let’s close with the bottom line in what is a rather complex development. After HMRC kicked off PSC payroll compliance checks, following a decade-long break, contractors must handle these with real caution, given that they could lead to full blown IR35 investigations.