What are the fines for IR35 non-compliance?

In April 2017, the off-payroll working rules (commonly referred to as the IR35 rules) were changed to shift responsibility for the determination of contractors’ employment status to public sector bodies. In April 2021, the same rules were rolled out to cover medium and large private sector businesses.

In this article for employers with off-payroll staff, we examine:

Which bodies and companies now have to determine contractor employment status
Why employment status is so important to HMRC
Why employers now have to check for this
What employers need to do to come up with a correct status determination
The fines for getting IR35 wrong
What you can do if HMRC wants to investigate
Creating a contractor-friendly, outside IR35 environment where your company or organisation is fully protected

For more information on IR35 compliance for employers, please call +44 (0) 203 051 9792, email [email protected] or fill out the form below.

Which bodies and companies have to determine contractor employment status?

All public bodies and medium to large businesses now have to determine the employment status of their off-payroll workers.

For the purposes of IR35, an off-payroll worker is generally an independent contractor providing services that benefit your company or organisation. These contractors then bill you via their own limited company (sometimes called personal service companies).

Although most contractors work through a personal service company, some are self-employed (similar to a sole trader). This is however quite rare because sole traders pay much larger amounts in income tax and National Insurance than limited company contractors.

What is “employment status” with respect to IR35 status?

IR35 is a “disguised employment” test. HMRC uses it to determine whether the circumstances under which an independent contractor operates working for you are actually those of an employee.

HMRC estimates that only one in ten employers correctly apply IR35 rules to their engagements with limited company contractors.

Why is this important? When an arrangement is deemed to be outside IR35 – in other words when this is a genuine customer-supplier relationship – the tax liabilities on both parties are a lot lighter.

So this means that, if HMRC’s estimate about non-compliance with IR35 rules is correct, significant amounts of unpaid taxes are accrued under these arrangements every year.

Why did HMRC shift responsibility to employers?

Previously, a system of contractor IR35 self-determination operated.

The problem for HMRC with this was that, over time, contractors became experienced in working with clients to create written contracts and working conditions that were outside IR35.

They had the incentive to do this. If a contractor declared themselves outside IR35 but was later found to be inside IR35, they would be responsible for paying unpaid taxes and a fine.

HMRC decided to flip this completely.

This was partly because employers did not have much experience of or knowledge in creating an outside IR35 environment for their off-payroll workers (no offence intended). The bigger hammer blow was that employers now became financially liable for any mistakes under the new rules.

These changes had two major effects:

Fewer situations to investigate. HMRC’s investigative teams were stretched previously because they had 100,000s of contractors to investigate. There are far fewer clients than contractors meaning that they could now employ their resources better.
Much bigger financial penalties. Previously, they got unpaid taxes and fines from single contractors. Now, they might score dozens of wins if they investigate a public sector or private sector employer and find that there have been many mistakes with contractor arrangements.

You might think that many employers would rely on HMRC’s Check Employment Status for Tax (CEST) online tool.

Quite correctly, they did not rely on this. CEST has been buggy since 2019 and it’s unable to determine IR35 status in one in five cases. As an IR35 determination test, it falls short in a number of different areas.

So rather than take their chances, many employers just declared all contract work within IR35.

Creating a status determination statement

With each contractor, you, as the end client, need to create a status determination statement. The statement covers the particular circumstances of the engagement you have with each individual member of your flexible workforce.

You need to share this with your contractor prior to starting work and to any other organisation in the supply chain, like a recruitment agency.

The statement contains the reasons why you believe your relationship with a contractor is inside or outside IR35.

Please note that, as HMRC is able to run an IR35 compliance check on you, your contractor is also able to lodge an IR35 status determination appeal.

How much are the fines if we get status determination wrong?

Before the level of fine you pay is determined, you’ll have to pay all the income tax, National Insurance contributions and, if applicable, Apprenticeship Levy fees. They’ll be rolled up to the end of the current financial year and you must make a “deemed payment” for each contractor whose IR35 status was assessed incorrectly.

The fine is based partly on the size of the deemed payment, how thorough the checking you did into an off-payroll worker’s IR35 status was (before and during the contract) and on how well you cooperate with HMRC during the enquiry process.

The fine you pay can be nothing or up to 100% of the deemed payment per contractor.

HMRC operate the following criteria in ascending order of seriousness for consideration when determining the level of fines:

Reasonable care. If you can show that you applied due diligence in your assessment but got it wrong, you probably won’t be fined.
Careless. This is where reasonable care was generally taken but a careless error in an important area of consideration was made.
Deliberate non-compliance. This might be where you have received advice from a third party or used the CEST tool but have ignored it and have not added a particular contractor to your payroll.
Concealed deliberate non-compliance. This might be similar to the above but taking deductions from a contractor’s pay but not registering them on the payroll nor sending their deductions to HMRC.

What if HMRC want to launch an investigation?

HMRC will contact you by letter in the first instance informing you that they want to run checks on your processes and systems for determining IR35 status.

You can respond to these requests by phone or in writing. We would always recommend doing so in writing because this gives you more time to find the evidence you need to support your case.

Investigations can drag on for a number of years so we strongly suggest that you cooperate with HMRC’s investigation team to get everything concluded in good time.

If HMRC disagrees with your initial assessment, you can take them to a tax tribunal. HMRC loses many cases presented to the First Tier Tribunal but, overall, it’s best not to get this far down the road because of the time and expense you’ll have to sacrifice.

Creating a contractor-friendly workplace outside IR35

The recent changes to IR35 legislation have caused great concern to many businesses and public sector organisations.

It’s important to remember that the determining factors of independent service provision have not changed. All that is different now is who is responsible for determining it.

Create an attractive environment outside IR35. Give your company the best chance of attracting contractors with the skills and experience you need ahead of your competitors with CoComply. Get in touch with us today.