HMRC IR35 Enquiries and Compliance Checks: Defence Guide

What actually triggers an IR35 status enquiry

HMRC opens very few status enquiries at random. Most begin with data. Agencies file quarterly employment intermediaries reports listing every contractor they pay gross, so HMRC already knows which limited companies are working through which agencies for which clients. A personal service company filing accounts that show a low salary, large dividends and a single dominant customer fits a profile, and profiles feed risk scoring.

The second common route is sideways spread. When HMRC runs an employer compliance check on a medium or large client under the off-payroll rules, it reviews how that organisation reached its status determinations. Weak determinations, blanket decisions or missing paperwork on the client side can lead officers to the individual engagements behind them. Sector campaigns work the same way: HMRC has historically concentrated effort on areas such as broadcasting, public sector bodies and oil and gas, opening clusters of enquiries at once. A third route is the ordinary corporation tax or PAYE enquiry that widens once an officer notices contractor-style accounts. Whatever the trigger, the legal question is the same one explained in the guide to the IR35 status tests: would this person have been an employee if engaged directly?

The opening letter and the first response

The first contact rarely says IR35 in the heading. It usually arrives as a check of employer records, a compliance check into a specific tax year, or a letter asking about the company’s arrangements for providing services to clients. Buried in the questions will be requests about contracts, who controls the work, whether a substitute could be sent and how the engagement operates day to day. Those questions map directly onto the status tests, and the answers given now will be quoted back for years.

Three habits protect the position at this stage. First, never respond by phone or in a meeting before taking advice. Officers are entitled to ask for a call, but the taxpayer is entitled to deal with everything in writing, and written answers can be checked, drafted carefully and kept consistent. Second, answer the questions asked and nothing more. Volunteering opinion, history or commentary expands the enquiry. Third, get the working practices statement right the first time. An accurate, detailed account of how the engagement really operated, agreed with the contractor’s own records and ideally consistent with what the client would say, is the foundation of the whole defence. A specialist enquiry defence adviser will usually take over correspondence at this point so every reply goes through one disciplined channel.

Information notices: what HMRC can and cannot demand

Most document requests start informally, and cooperating with reasonable informal requests is usually sensible because it earns penalty mitigation later. If cooperation breaks down, HMRC can issue a formal information notice under Schedule 36 to the Finance Act 2008, which compels production of documents and information that are reasonably required to check the tax position.

The reasonably required test has real limits. HMRC cannot demand documents that are not in the taxpayer’s possession or power, cannot require legally privileged material such as advice from a solicitor, and cannot use a notice as a fishing expedition into years or taxes outside the stated check. Information notices can be appealed to the tribunal within 30 days unless the tribunal pre-approved the notice, and an appeal is worth considering where a request is plainly excessive. HMRC can also issue third-party notices to agencies and end clients, so assume that contracts, timesheets, emails and onboarding records held by the client may reach the officer independently. That is one more reason the contractor’s account of working practices must match the documentary record rather than an idealised version of it.

Keeping the contractor and client stories aligned

Status enquiries are frequently lost on inconsistency rather than on the law. If the contractor describes an autonomous project specialist while the client’s hiring manager describes a team member who attends stand-ups and books leave through the line manager, the officer will believe whichever version helps the assessment. Where the relationship allows it, let the client know an enquiry is open, agree who will answer questions about the engagement, and make sure both descriptions rest on the same documents. Nothing improper is involved in coordinating accuracy; what damages cases is two honest but differently framed accounts of the same facts.

How far back HMRC can go

Assessment time limits depend on behaviour, and the difference is enormous. The standard window is four years from the end of the relevant tax year. Where HMRC can show the loss of tax was brought about carelessly, the window extends to six years. Where the behaviour was deliberate, it stretches to twenty years. Each tax year stands alone, so a long-running engagement can produce a stack of assessments, each carrying its own tax, National Insurance and interest.

This is why arguments about behaviour matter twice over. The same finding of carelessness that extends the assessment window from four years to six also moves the penalty position from zero to a chargeable band. Defending the quality of the original status decision, the advice taken, the reviews commissioned, the evidence kept, is therefore not just about penalties. It directly limits how many years are in play at all. Interest, by contrast, is not behaviour-dependent: it runs on every underpaid amount from its original due date until payment, and there is no mitigation for it.

Penalties and the reasonable care shield

Penalties for inaccuracies are charged as a percentage of the potential lost revenue, banded by behaviour. The bands work as follows.

• Reasonable care taken: no penalty at all, even where the status conclusion turns out to be wrong.
• Careless: up to 30 per cent of the lost tax, reducible for the quality of disclosure and cooperation.
• Deliberate but not concealed: 20 to 70 per cent.
• Deliberate and concealed: higher still, the most serious civil category.

For a status case, reasonable care means being able to show a genuine, contemporaneous attempt to get the answer right. Commissioning a professional contract and working practices review, keeping the CEST output with a record of why each answer was given, taking advice when the facts changed, and revisiting the position at renewal all count. Reaching an honest conclusion that a tribunal later disagrees with is not carelessness; doing nothing and hoping is. Within the careless band, penalties are reduced for telling HMRC about the error, helping quantify it and giving access to records, and a careless penalty can sometimes be suspended entirely on conditions. Deliberate findings are rarer in status work but devastating where made, because they bring the twenty-year window with them.

Settle or fight: costing the decision honestly

At some point in most enquiries HMRC states a view, and the choice becomes settlement or litigation. The honest way to make that choice is arithmetic plus evidence, with sentiment removed. Start with the exposure: deemed employment income tax and National Insurance for every open year, less any offsets, plus interest throughout, plus the likely penalty band. Then weigh the evidence against the status tests. A genuine exercised substitution, light contractual control and a portfolio of clients make a strong tribunal case. A decade embedded in one client’s team with a fettered substitution clause does not.

Litigation has costs that never appear in the assessment. First-tier Tribunal cases routinely take years from enquiry to hearing, professional fees accumulate throughout, and the First-tier Tribunal does not generally award costs to the winner, so even victory leaves the fees unrecovered unless insurance covers them. Settlement buys certainty and stops interest accruing on the settled amounts, and HMRC’s alternative dispute resolution process offers a structured middle path where the facts are genuinely arguable. None of this means weak HMRC positions should be paid off. It means the decision should be made the way a business makes decisions, on expected outcomes, not on the principle of the thing. A contractor who has already been through a determination dispute will recognise the same logic from the CEST and Status Determination Statement process: evidence quality decides everything.

Using alternative dispute resolution before committing to a hearing

ADR places an HMRC-trained facilitator between the two sides to test where the real disagreement lies. It suits status cases well because so much turns on findings of fact, and a structured discussion often narrows the dispute to one or two issues, perhaps whether a substitution clause was genuine, or how much day-to-day direction the client actually exercised. The process is voluntary, does not stop appeal deadlines running, and costs little beyond adviser time. Even where ADR does not settle the case, it usually reveals how confident HMRC really is, which sharpens the settle-or-litigate decision.

The April 2024 offset rules and the end of double taxation

Before April 2024, a status flip under the off-payroll rules produced an unfair result. The deemed employer became liable for PAYE and National Insurance on the full fees, while the corporation tax, dividend tax and personal tax the contractor and the personal service company had already paid on the same income sat ignored. The Exchequer collected twice, and clients facing compliance checks carried a grossly inflated bill.

Since 6 April 2024, HMRC can set off tax already paid by the worker and their intermediary against the deemed employer’s PAYE liability when a determination is overturned. The set-off is estimated by HMRC from the records it holds rather than negotiated line by line, but it removes most of the double charge. The practical effects run in several directions. Clients facing off-payroll compliance checks now settle on far more realistic numbers, which makes them less inclined to fight defensible cases and less inclined to impose blanket inside-IR35 policies out of fear of catastrophic liability. Contractors should understand that the offset reduces the deemed employer’s bill, not their own: a worker whose engagement flips inside has effectively had their company taxes redirected to cover the PAYE failure, and dissolved companies and missing records complicate the estimate. The mechanics of who carries liability in each chain are set out in HMRC’s guidance on the off-payroll working rules.

Fee protection insurance: what it pays for and what it never will

Tax investigation fee protection insurance, often sold alongside an accountancy package or as a standalone policy, covers the professional costs of being defended: the adviser’s fees for handling correspondence, preparing the working practices evidence, negotiating with the officer and, on better policies, representation at tribunal. Over an enquiry that runs for years, those fees can reach tens of thousands of pounds, so the cover has real value.

What no policy pays is the tax itself, the National Insurance, the interest or the penalties. If the engagement was inside IR35, that liability lands regardless of insurance. Before relying on a policy, check four things: that IR35 and employment status enquiries are explicitly within scope rather than excluded as a specialist risk, that the indemnity limit is high enough for a multi-year dispute, that enquiries already open or arguably foreseeable at inception are not excluded, and who chooses the adviser, because some policies only fund the insurer’s panel firm rather than the specialist the contractor wants. A policy that funds an expert defence changes the settlement calculus described above, since fighting a strong case no longer means funding it personally.

Build the defence file before HMRC ever writes

Every stage of an enquiry rewards the contractor who prepared early. The file that wins arguments is assembled during the engagement, not reconstructed from memory three years later under deadline pressure. It should hold the signed contracts for every engagement and renewal, a working practices confirmation agreed with the client while the facts are fresh, evidence of any substitution that actually happened including who was sent and who paid them, the status review or CEST record behind the original conclusion, and the everyday exhaust of an independent business: invoices to multiple clients, insurance certificates, equipment receipts and correspondence showing the contractor deciding how the work was done.

Kept current, that file does three jobs at once. It anchors the first response so the narrative is accurate and consistent. It evidences reasonable care, which caps penalties at zero and holds the assessment window to four years. And it gives any adviser the raw material to push back hard from the opening letter rather than playing catch-up. A specialist accountant can audit what exists today, identify the gaps while the client relationships needed to fill them are still warm, and put a review cycle in place so each renewal refreshes the evidence rather than eroding it.