What triggers IR35 investigations by HMRC?

What triggers IR35 investigations by HMRC?

It might seem to the casual limited company contractor that a letter from the Revenue alerting him of an IR35 investigation is down to fate, however, there’s usually something that’s aroused a tax inspector’s suspicions. It’s wise to know in advance what the various triggers could be. So, here’s our guide to things you might do or fail to do as a contractor to prompt this potentially onerous and stressful process.

Direct and indirect triggers

IR35 expert Andy Vessey of Qdos Consulting explains that HMRC can be prompted to launch an IR35 investigation as a result of a contractor working in a specific sector which it believes to be a medium to high risk area for tax non-compliance. The Revenue also has a Transparent Benchmarking team which monitors contractor activity and may act if something arouses their suspicion. In other cases, the contractor may simply be engaging in behaviours that arouse official suspicion.

Sometimes an investigation is triggered directly because a contractor meets the Revenue’s IR35 risk criteria, but other times the catalyst may be more indirect, such as a finding from investigations into other areas such payroll, VAT or corporation tax.

Given that HMRC has dedicated teams specialising in monitoring the work of limited company contractors, it’s best to be prepared and take the requisite measures to avoid the pain, time and stress of an IR35 investigation.

All of HMRC’s guidance on IR35 has been collected into a single online source which was published in June 2014: Intermediaries Legislation (IR35) - Working through an intermediary, such as a Personal Service Company.

Targeted sectors campaigns

Vessey explains that a key criterion influencing HMRC’s decision to launch an investigation is simply the sector the contractor happens to be working in. And it’s not necessarily “anti-contractor” – sectoral risk and targeting by HMRC also extends to other forms of work engagement.

As Vessey puts it: “Investigation teams target sectors its risk profiling teams identify as being at high risk of non-compliance with HMRC IR35 rules. Campaigns have included doctors, dentists, teachers and trainers, and health professions such as physiotherapists, as well as restaurants in London and haulage firms in the Midlands.”

Putting it frankly, HMRC doesn’t regard anyone as off-limits when it comes to rooting out IR35 noncompliance.

According to Vessey, HMRC will on occasion target specific areas for IR35 investigations due to media pressure on their inspectors to take action, which the Government will often yield to and direct its taxmen to investigate. This happened in the public sector when off-payroll working models ignited intense media interest.

The result, as Vessey notes, was heightened scrutiny of these models by HMRC in public sector organisations, which were required to identify all of the off-payroll workers who worked for them – in other words, contractors. Exceptionally specific information about these contractors was passed to the Revenue by public sector end clients, so that each of them could be reviewed by inspectors vis-à-vis their IR35 status. The data supplied triggered literally hundreds of IR35 investigations.

HMRC’s data mining and analysis to identify IR35 noncompliance

Random IR35 inspections by HMRC are a thing of the past. While it was once common practice for local tax inspectors to open a series of random investigations into, say, VAT, PAYE income tax or corporation tax on their patch, which had a somewhat hit-and-miss potential to catch noncompliant contractors, technology has changed all that.

Today, there are vastly more efficient methods available to the taxman for targeting possible IR35 noncompliance. The Revenue’s risk assessment resources extend from regional to local levels and use immensely sophisticated software to analyse public sector databases and pinpoint possible noncompliance.’

That means, Vessey explains, that contractors who have discrepancies in their tax paperwork or who have submitted inaccurate information will almost certainly be identified by the software, prompting an inspector to review their file and then decide whether to proceed with a formal investigation of the “suspect’s” IR35 status. Any contractor with markedly fluctuating profits or expenses may also prompt an investigation.

The art of self-protection: don’t give HMRC cause to suspect that you may be breaking the rules

Vessey is clear about what this entails. He says: “Contractors should maintain high quality and accurate business records and use the services of a professional to ensure their information is filed correctly. Otherwise they could be inviting a HMRC tax inspector to come and investigate their IR35 status and other tax affairs.”

Should legitimate but exceptional figures appear in the tax return, such as marked surges or declines in sales profits or expenses, Vessey advises contractors to include a note in the supplementary section of the corporation tax return clearly itemising the reasons for the change. This may persuade an inspector to waive a formal review instead of triggering one.

However, from years of experience, Vessey believes that tax inspectors who find their attention drawn to other aspects of a contractor’s tax documentation, such as corporation tax, PAYE or VAT, will almost certainly, once they’re aware that they’re dealing with a contractor, refer the matter on to a specialist IR35 investigation team.

Real time information (RTI) and the service company question

Given that HMRC routinely mines data within business records held on online databases, in addition to ensuring that this information is discrepancy and error free (or contains clear explanations in supplementary notes as to why the discrepancy arose), contractors should always file accurate and timely real time information (RTI) submissions, taking care to answer the personal service company question on their tax returns clearly and accurately.

RTI, Vessey explains, means that it’s no longer necessary for contractors to file a P35 with the service company question, because they answer the same question under RTI when their final return is due for a tax year.

He continues: “Despite tax barrister Keith Gordon’s successful campaign to prove that contractors cannot be compelled to answer the service company question, in practice contractors should be honest and fill it in. Failing to complete the question simply places further doubt in an inspector’s mind and could be the trigger for an IR35 investigation by HMRC.”

While P35 is a thing of the past, consistently failing to get RTI right will immediately plant the seeds of suspicion in the taxman’s mind and prompt him to wonder what else the contractor is getting wrong, pushing the him or her higher up the inspector’s tax rating, Vessey warns.

HMRC’s Transparent Benchmarking Team

This team specialises in calculating average performance ratios for different kinds of businesses based on the vast quantity of data it collects from corporation tax returns, returns filed by sole traders and personal self assessment tax returns.

The team constructs profiles for various trades and professions, such as painters, decorators and driving instructors, and sets about building a picture of the average profitability that businesses in these areas demonstrate. It is highly likely that business such as “engineering consultants” and “IT contractors” will be included on the team’s list.

And that boils down to one thing: contractors in these areas of business are likely to start receiving querying letters from HMRC if their profits, business costs and expenses are markedly outside the designated average for their specialism as determined by the benchmarking team.

The IR35 contract review service and the role of anonymous tip-offs

In Vessey’s professional opinion, it’s best to avoid using HMRC’s IR35 contract review service. While it’s ostensibly a support service for contractors wishing to discover if their contract is inside or outside IR35, Vessey has come to the view that it functions as a source of leads for the Revenue’s four central compliance teams.

The service may indeed prevent an IR35 enquiry, but Vessey believes it can also trigger one. Formally, the service promises not to investigate for three years if a contract is found to be outside IR35, and also promises not to pass on caller details to IR35 inspector colleagues. But Vessey believes that high risk contractors using the service face an even bigger risk. He says: “If an HMRC officer reviews a contractor’s contract and finds it places the contractor at high risk of being inside IR35, of course they are going to forward the details to their IR35 colleagues. I certainly don’t trust them not to.”

And there’s a final source of triggering an IR35 investigation that Vessey has come across in his professional work: anonymous tip-offs.

He says: “Disgruntled spouses or partners have been known to anonymously tip-off HMRC about their spouse/partner’s financial affairs.

Ordinarily an anonymous tip-off would start as an income tax or corporation tax investigation, but once the inspector knows a contractor is involved, they will call in the specialist IR35 units.”

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