A contractor's guide to IR35 penalties and interest

Naturally, there’s lots of interest in what makes up the jaw-dropping sums which those caught by IR35, ranging from high-profile TV presenters to public sector departments, get landed with under the legislation.

In the public sector alone, incorrectly operating the off-payroll rules has seen various taxpayer-funded offices rack up around £250million in tax bills, writes Nigel Nordone, head of tax at Qdos.

A single IR35 penalty? That’ll be £15million please

Distinct from the IR35 liabilities themselves, the Ministry of Justice, as just one example, was issued a £15m penalty for its “careless” application of the off-payroll rules.

With this in mind, it’s worth a closer look at HMRC penalties under IR35, including the secondary but still significant cost aside to the liability itself – interest owed.

Why are IR35 penalties issued by HMRC?

It probably goes without saying, but I’ll state the obvious – penalties are levied against the party (or parties) responsible for submitting the incorrect information to HMRC. So that’s contractors, or -- under the off-payroll rules -- businesses.

While that £15m figure I cited at the outset might have sent you into panic mode, there’s no immediate need for alarm. HMRC only issues penalties where it can prove that the actions that a contractor (or end-client) has taken when deciding their status were careless or deliberate.

But where an incorrect IR35 status determination has been reached, if you can demonstrate that you took “reasonable care” in your assessment, it’s unlikely that HMRC will issue a penalty.

How are IR35 penalties decided?

While you might think a penalty would be tied in some way to the IR35 liability figure, that’s not necessarily the case. Instead, the penalty charge is based on, say, the contractor’s behaviour -- both the initial inaccuracy and the level of disclosure during HMRC’s review.

Specifically, that means whether any disclosures are unprompted i.e. you’ve told HMRC about an inaccuracy before they discover it, or prompted, such as following the beginning of an HMRC investigation.

Earlier disclosures are also viewed more favourably and may lead to a less severe penalty (in terms of an amount), than a disclosure made, say, four months into an investigation.

When are IR35 penalties issued?

Typically, penalties under IR35 are issued once HMRC has reached a final settlement figure following an investigation.

That figure is the outstanding tax liability, less any taxes that can be offset against it which the contractor will have already paid through their limited company (such as corporation tax).

Where does interest come into the IR35 picture?

Interest is charged on the outstanding liability -- where the payment is made to HMRC beyond the agreed settlement date.

With IR35 cases often taking years to settle, the total interest charged by HMRC can add up to a considerable sum. Interest is calculated from the date the taxes were due -- and continues to accrue until HMRC receives payment.

How can contractors combat mitigate the IR35 penalty/interest risk?

There’s one way to reduce the interest accrual on liabilities -- making what’s known as a ‘payment on account’ to HMRC during the IR35 review process.

Payments on account are a way of paying a tax bill.

Doing so while under an IR35 investigation effectively stops the interest accrual on the amount you pay.

If, for example, you made a £10,000 payment against any anticipated IR35 liability, the interest would stop accruing on that portion of the overall liability. If the total liability were £20,000, interest would continue to accrue on the remaining balance.

If the IR35 investigation concludes that you were operating compliantly, any payments on account you’ve made will be refunded.

If you win your IR35 case, does HMRC cancel the penalty?

In theory, a HMRC penalty may be mitigated, based on the contractor’s behaviour as outlined above. 

But in practice, HMRC rarely reduces penalty charges. If the tax authority wins its case, it will charge liabilities, penalties and interest as it deems appropriate.

However, if a contractor can demonstrate that they were genuinely self-employed -- to HMRC and a tribunal -- then there is no liability to pay. No liability, no penalties, no interest!

Contractor or client? Either way, you’re in the crosshairs of IR35/OPW penalties and interest

Due to the introduction of the off-payroll working rules (in the public sector on April 6th 2017, and in the private sector on April 6th 2021), the responsibility for determining IR35 status, and the liability for incorrect determinations, has shifted, meaning that these concerns are more relevant for end-clients than contractors.

However, contractors engaged by small businesses -- and contracts held prior to the introduction of reforms -- are still fair game as far as HMRC is concerned. Ensuring your compliance, and being able to demonstrate it, therefore remains essential in the event HMRC opens an investigation.