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How to avoid an IR35 investigation

Contractors seeking to avoid being targeted for an IR35 investigation by HMRC can adopt a range of strategies that will help reduce the likelihood of their being targeted for a review.

The good news is that classic contractor behaviours, such as paying a low salary and high dividend, are unlikely to lead to an investigation. HMRC’s specialist IR35 teams, and not local offices, determine who to investigate and why.

However, contractors, particularly high earners, that HMRC is on the lookout for opportunities to generate a good yield from their compliance activity, so they should focus on filing tax paperwork correctly and on time.

Making mistakes and late filing attract attention

A guaranteed way to get on HMRC’s radar is to submit tax paperwork late and/or with errors. An inspector will work on the principle that if a contractor has made mistakes with, for example, their corporation tax return, they are probably making other mistakes that could lead to an incorrect tax calculation.

Contractors should take such simple steps as hiring an accountant to file their tax returns and other tax paperwork. And they should do what they can to avoid making a ‘generalist’ tax inspector think IR35 might apply. Although major HMRC offices such as Cardiff handle things like tax returns, they will refer a contractor’s case to a central specialist IR35 team if they believe that IR35 could apply.

Accounts analysis

Because HMRC uses a range of sophisticated software to analyse all the data available on individual taxpayers, contractors may be at risk of being investigated without even realising it.

HMRC has dedicated teams that use data mining and analysis to flag potential targets for investigation. So, if a contractor is particularly profitable one year and much less so the next, HMRC’s software will spot this and flag the case for a human tax inspector to review.

Contractors may be able to avoid this type of investigation simply by including explanatory notes on their tax return: HMRC will actually accept a reasonable explanation as to why expenses might be particularly high when compared to previous years, which could nip a potential IR35 investigation in the bud.

IR35 best practice

There is no substitute for good, old-fashioned IR35 best practice: Contractors should begin each contract with a contract dossier that will start with the expert contract review commissioned before accepting the contract and a confirmation of arrangements signed by the contractor’s client.

It will then include all the emails and meeting notes that point to the contractor being outside IR35. Ideally, it will also include an example of a substitution.

A contractor should be able to produce a dossier for each contract. That way, if they are investigated by HMRC, the professional adviser paid for by their tax investigation insurance has all the ammunition needed to quickly shut down an investigation, or to persuade the taxman not to pursue it.

Beware of ‘grasses’ – be nice to your partners/spouse/business associates

Interestingly, some reviews are started as a result of anonymous tip-offs to HMRC: Contractors won’t be ‘shopped’ directly because of their IR35 status, but what we have seen are disgruntled ex-spouses, partners and business associates calling HMRC, often because the contractor has boasted about how little tax they pay.

Although tip-offs identifying contractors are not that common, contractors should be very careful who they speak to about their business and tax affairs and try to avoid giving away too much information to anyone other than those who can be totally trusted.

It takes remarkably little effort for contractors to adopt IR35 investigation-avoiding strategies. But the effort is well worthwhile if it results in killing an investigation before it gets off the ground.

Updated: 03 November 2013

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