How many contractors are caught by IR35?

The off-payroll working rules (IR35) have been in place for almost two decades as a way to prevent ‘disguised employment’. This is the practice of providing services to a client and working to all intents and purposes as an employee – but being designated as self-employed and thereby circumventing certain tax obligations.

Disguised employment is estimated to have cost HMRC many millions in underpaid taxes, and puts clients at an unfair advantage, where they receive all the benefits of having a full-time employee but do not have to pay as much in tax or insurance. If you are a contractor who provides services to clients through a PSC (personal service company) or other similar intermediary, it is crucial that you understand the IR35 rules and what they mean, in order to avoid being caught by them.

What is IR35?

Introduced in 2000, IR35 aimed to close the tax loophole being exploited by many companies at the time. The current version of the rules places the responsibility of designating employed or self-employed status on the client receiving the services if the work is being carried out in the public sector. Further updates to IR35 in 2021 will bring the private sector and other sectors in line with these rules.

What happens if you get caught by IR35?

Any IR35 investigation carried out by HMRC will result in the contractor being found inside or outside IR35. If you are outside IR35, this means that you are legitimately self-employed or a sole trader and the regulation therefore does not affect you. However, if you are caught inside IR35, this means that you have wrongly been designated as self-employed when in fact IR35 applies to you – and it is possible that you have underpaid tax as a result.

HMRC will determine whether you should be deemed employed or self-employed by examining the manner in which your work is carried out, taking into account a number of different factors:

• Your level of control and agency over the work that you perform
• Whether your work could be carried out by someone else in your absence
• Whether you have to accept work or are able to turn it down
• Whether you are supplied with company equipment
• Whether you are treated as an employee of the company and receive benefits as such
• Whether you have to follow prescribed working patterns and hours

What are the penalties for being caught inside IR35?

Under rules introduced in 2009, the penalties for being caught inside IR35 depend on what HMRC deems to be the outcome of an investigation, and are currently as follows:

• You must pay a penalty of 30% of unpaid tax if HMRC finds that you were careless about your employment status
• You must pay a penalty of 70% of unpaid tax if HMRC finds that you knew your status was inaccurate and failed to act
• You must pay a penalty of 100% of unpaid tax if HMRC finds that you have actively tried to conceal your IR35 status

An IR35 investigation can go back as far as 20 years into your tax records if it is considered to be necessary.

How many IR35 investigations take place annually?

HMRC does not disclose exact details of its investigative practices and therefore there is no definitive annual figure for IR35 investigations. However, it is believed that HMRC is committed to at least 250 investigations per year, and the figure may be as high as 1,000.

Within this figure, the number of investigations which result in a contractor being caught outside IR35 is relatively low. However, contractors are caught out and made to pay substantial sums of money every year, and you can never be sure that a letter from HMRC is not going to drop through your letterbox.

It is therefore crucial that you are not only clear on whether you fall inside or outside IR35, but proactive and decisive in ensuring that tax is paid correctly. Any omissions or careless errors could be penalised by HMRC, so you should always take the approach of being fully prepared for an investigation should one arise.