Risk assessments and back-up plans are necessary to run a successful business as a contractor, particularly when it concerns avoiding penalties from HMRC.
Letter from HMRC
If you have received a letter from HMRC requesting proof of your tax-paying position, it’s essential to cooperate and respond within a reasonable timeframe. Contacting your accountant or People Group Services company immediately will give you confidence that your financial information is organised, compliant, and ready to forward to HMRC promptly.
Your IR35 status is an element HMRC considers to determine the amount of tax you should pay. Specific rules must be adhered to before you can identify as being within IR35 status or operating outside of it (as most independent contractors prefer to do).
Various stipulations set out by HMRC govern whether you are considered an independent contractor who must declare their earnings and taxes. If your work arrangement describes you as an employee, you will be taxed similarly to the clients’ staff.
Below you can find guidance on how to build a case to support your tax-paying position in respect of IR35.
Income Declaration: Low Salary and Dividends
In terms of your income, personal service companies can legally accept a minimal salary and the rest of your earnings in dividends. However, should HMRC perform a risk assessment on the division of your wages, it’s highly likely to prompt them to initiate an investigation into your financial status.
This is to check whether the dividends are being distributed correctly. For example, you will need to prove shareholder meetings have been arranged and dividends have been voted for and shared accordingly. In respect of this point, be vigilant about how you declare your income.
Contract Defining Working Relationship
To maintain an external status of IR 35 as an independent contract, ensure that you have a written agreement in place with a client. This agreement must clearly outline your various terms and conditions. It is imperative that this document is signed by both parties, and dated.
The information incorporated into the contract must:
- Specify that you will work on your own volition within the timeframe given.
- Highlight places you will work away from the client’s premises.
- Explain you shall monitor your workload and progress, and supervision from the client is not needed to track hours, breaks, and so forth.
- Broach the subject of being unfit to work, and detail that you may recommend a substitute to fill your position until you can return to the project.
Distinguish your position as an independent contractor in clear terms on the contract to prevent misinterpretation by HMRC if or when they inspect it.
A paper trail is an essential part of building your case should HMRC deem it necessary to audit your IR35 status. Keep a record of the following;
- All contract negotiations.
- Any contractors you have used to fill your position or any substitute’s details you keep on record if you’re unable to complete your contracting services.
- A document highlighting the financial risk to you as an independent contractor if a contract is terminated.
- Receipts and proof of business expenses that reveal you are working away from the client’s premises. This shall help solidify your position as a contractor working on your terms in places of your choice.
It’s important to note, no amount of preparation can guarantee you will not be approached by HMRC regarding your tax status. However, the advice above can help you prepare at least, in the event a letter from HMRC arrives.