IR35 must be considered on an engagement-by-engagement basis, and wrongly assuming that your business is "outside of IR35" can result in penalties.
Very few contractors can state with complete confidence that "My business is outside of IR35”. Yet this regularly happens - with reasons such as having more than one client, the client being overseas, the contractor has been advised that my contract is “IR35-friendly”, there is no agency in the chain, or the engagement never lasts as long as two years.
All of this might be true, but IR35 must be considered engagement-by-engagement, whether by end clients under the new private sector off-payroll rules or contractors who still retain responsibility for IR35 because they are engaged by a small company or one based wholly overseas. Without undertaking the proper and necessary due diligence for each and every engagement, you absolutely cannot reach that conclusion.
A contract-by-contract approach is key
Naturally, most contractors want to operate ‘outside’ of IR35, especially where they remain responsible for determining their own IR35 status under Chapter 8 of Part 2 ITEPA 2003. However, being ‘outside’ of the legislation is not simply a label of choice that attaches itself to a contractor’s business on an indefinite basis. The requirement of the legislation is clear: contractors must consider their IR35 status on a contract-by-contract basis (relevant engagements). This could well mean that contractors find themselves regularly moving from being ‘inside’ to ‘outside’ IR35 and vice versa, based upon consideration of the facts of their individual relevant engagements in the context of case law precedent.
This starts with the three key status tests of: personal service, control and mutuality of obligations, established in the seminal case of Ready Mixed Concrete (South East) v Minister of Pensions and National Insurance [1968] 2QB 49. The importance of these tests appears to have been underlined by the recent Court of Appeal decision in Atholl House (Kaye Adams), which overturned the decision of two lower courts which deemed the engagements outside IR35 on the basis of in-business factors.
So, when a contractor’s business finds itself subject to an IR35 enquiry, under Chapter 8 of Part 2 ITEPA 2003, the key question HMRC will ask in the opening ‘Check of Employer Records’ Letter is:
“Will you please also tell me whether you have considered the possibility of the company being subject to what is commonly referred to as the IR35 legislation and the date you considered it? If you have, and you have concluded that the company is not subject to that legislation, then please explain to me the basis upon which you arrived at that conclusion.”
For those who have simply chosen to operate ‘outside’ of IR35, due to no other reason than the financial benefits of doing so - without undertaking the necessary due diligence to support such a decision - they may find themselves not only with a liability for unpaid PAYE and NIC. This includes accrued interest and also a hefty penalty if HMRC believe the decision of being ‘outside’ of IR35 was incorrect and ‘reasonable care’’ had not been taken.
Potential penalties
HMRC calculate penalties on inaccurate returns on the basis of taxpayer behaviour, which can range from ‘an error despite taking reasonable care’ where there is no penalty, to an error which is ‘deliberate and concealed’ where the penalty could be 100% of tax due. Neither of these extremes is likely to apply (see here for more detail), but if you haven’t done your due diligence, there will have been a failure to take reasonable care and you will be looking at a penalty which could be an additional 15% to 30% of the tax due.
To further support this point, Markel Tax is currently representing several contractor businesses with regards to their IR35 enquires, where HMRC have requested evidence from the contractor (including written evidence such as an IR35 contract review opinion report) which supports their decision and that the correct application of the legislation has been applied. It is clear that HMRC are looking to establish penalties early on, to be applied at a later date during the investigation if PAYE Regulation 80 determinations and/or NIC Section 8 Notices are raised and issued.
For those that have either taken it upon themselves to understand the legislation correctly and have applied appropriate case law principles to the facts of their engagement or have engaged an independent specialist advisor to assist in their decision making process, then demonstrating ‘reasonable care’ should be relatively straightforward and penalties can easily be avoided, even if HMRC disagree with the overall IR35 opinion.
However, for those that are unable to evidence and support their actions and decisions in relation to their IR35 status, they may face significant additional liabilities, which could easily have been avoided.
To conclude...
Contractors should not make the mistake of automatically assuming that IR35 doesn’t apply to the contractual engagements on an ongoing basis. Establishing the correct IR35 status requires careful and continuous consideration of all circumstances that form part of the arrangements and crucially, for each engagement that the contractor’s business enters into. This equates to a review of the contractual documentation, as well as the actual working practises, specific to each engagement. For those that follow this practice, significant penalties can be avoided and for those that choose not to, or rely upon naivety as an excuse, then it may well end up suffering a very costly error of judgement.
Click here to learn more about IR35 and how to determine your IR35 status.
