IR35 penalties: A contractor’s guide

Are you a contractor who supplies services to a client organisation? If you work in a similar manner to your client’s employees, then the off-payroll working rules (IR35) exist to make sure you pay the same tax as them and do not gain tax advantages by using an intermediary such as a PSC (personal service company). However, it is not always clear as a contractor whether you fall inside or outside IR35, and the type of work you do may vary in nature or not be quite as clearly defined as the criteria states.

In line with updates implemented by HMRC in 2017, if you work in the public sector then the responsibility for designating you as employed or self-employed rests upon the client receiving your services. As of 2021, this rule will be extended to the private sector and other sectors in order to bring everyone under the same rules.

If you are subject to an investigation by HMRC and it is found that your employment status has been incorrectly designated, or you are found to be circumventing the IR35 rules in any other way, the consequences for you and your business can be severe. It is therefore important to be fully aware of the penalties for any breaches of the IR35 regulation.

What is IR35?

As first introduced by the government in 2000, IR35 was designed to prevent the use of loopholes to avoid tax, by companies who supply their services via intermediaries – and therefore pay rates of tax which do not reflect the true nature of their work. ‘Disguised employment’, as it is known, was costing what was then the Inland Revenue many millions of pounds in lost taxes per year.

More recent updates which, as mentioned above, make the client rather than the contractor responsible for designating employment status, aim to mitigate further losses of tax which have occurred since the introduction of IR35.

You can find out more about ‘what is IR35?’ here.

What happens in an IR35 investigation?

If you are investigated by HMRC with regards to IR35, they will take a number of different factors into account:

• Supervision and control: Do you perform tasks as assigned to you by a line manager, or are you your own boss? Are you able to turn down tasks as you see fit?
• Substitution: Are you replaceable by the company or is your work indispensable? Could someone else do your job on your behalf in your absence?
• Nature of the relationship: Are you considered part of the team? Are you supplied with a uniform and equipment? Does your picture appear on the company website?
• Mutuality of obligation: Do you have to accept work? Do you have to work to a set pattern of hours and days per month?

If the answer to most of these questions is yes, then you are likely to be inside IR35 and if you have been designated as self-employed then you may be subject to significant penalties.

How far back can HMRC go in an IR35 investigation?

Should HMRC suspect that fraud or tax avoidance may have taken place, then they have the right to investigate your accounts and working practices as far back as 20 years if it is considered to be necessary.

What are the penalties for being caught inside IR35?

The updated penalty regime for IR35 was introduced in April 2009. Prior to this date, much of a contractor’s tax liability was up for negotiation, and the stringent new rules aimed to consolidate the level of penalties applied.

Where the old rules still apply (e.g. private sector small companies exemption, or where the end-client is based abroad) contractors caught inside IR35 with a wrongly designated employment status will have to pay back:

• A penalty of 30% of unpaid tax if HMRC deems that you were careless about your employment status but did not know it was inaccurate
• A penalty of 70% of unpaid tax if HMRC finds that you knew you were within IR35 and yet chose not to act
• 100% of unpaid tax if HMRC finds that you have actively tried to conceal your IR35 status and underpayment of tax

What is the duty of ‘reasonable care’?

There is an understanding that mistakes can happen, and IR35 payments may be levied in certain circumstances. However, where a duty of reasonable care has not been taken, penalties are issued as outlined above.

HMRC’s guidelines state that contractors should always check something they are not sure of, and that “whilst each person has a responsibility to take reasonable care, what is necessary for each person to discharge that responsibility has to be viewed in the light of that person’s abilities and circumstances.”