What Happens in an HMRC IR35 Investigation?
An IR35 investigation means HMRC believes your company is paying you as a contractor when you should be classified as an employee. If they succeed, the company owes PAYE income tax, National Insurance, and interest on every payment that should have been taxed at source. The bill can go back years.
We work with directors who receive IR35 enquiry letters and assume they can handle it themselves. In our experience, that approach costs more than it saves. IR35 investigations are technical, adversarial, and the amounts at stake are substantial.
A contractor paid £80,000 per year who is reclassified as an employee generates an annual tax shortfall of approximately £15,000 to £25,000 in employer NICs and PAYE. Over three years, that is £45,000 to £75,000 plus interest and potential penalties.
This is not a paperwork issue. It is a liability that can push a small company into insolvency.
Quick Answer on HMRC IR35 Investigations
IR35 (the off-payroll working rules) determines whether a contractor working through a personal service company (PSC) is genuinely self-employed or is effectively an employee of the end client.
Since April 2021, medium and large private sector clients (and all public sector clients since 2017) are responsible for determining the employment status of contractors they engage. If HMRC disagrees with your determination, they open an investigation.
The investigation examines the reality of your working relationship: does the contractor have the right to send a substitute? Does the end client control how the work is done? Is there mutuality of obligation? If the answers suggest employment, HMRC will assess the tax that should have been deducted and demand payment from the fee-payer (usually the company that engaged the contractor).
How HMRC Selects Companies for IR35 Investigation
HMRC does not investigate randomly. We see investigations triggered by:
- CEST tool inconsistency. HMRC’s Check Employment Status for Tax tool flagged your arrangement as inside IR35, but your company determined it was outside. HMRC reviews the discrepancy.
- Industry targeting. HMRC focuses on sectors with high contractor usage: IT, financial services, engineering, media, and healthcare. If your company operates in these sectors and engages multiple contractors, your risk is higher.
- Contractor complaints. A contractor who disputes their status (perhaps because they want employee benefits or redundancy pay) can trigger an HMRC enquiry.
- Pattern detection. HMRC’s Connect system identifies companies that have numerous PSC payments but no equivalent PAYE payroll, suggesting possible widespread IR35 non-compliance.
What Happens During an IR35 Investigation
Stage 1: Enquiry letter. HMRC writes to your company (or the PSC, for pre-April 2021 arrangements) requesting information about specific contractor engagements. The letter names the contractor and asks for contracts, working practices, and evidence of the employment status determination.
Stage 2: Information gathering. HMRC requests: the contract between your company and the PSC, the status determination statement (SDS), evidence of the factors considered in making the determination, correspondence with the contractor, evidence of how the work was actually performed (not just what the contract says), and details of payment arrangements.
Stage 3: HMRC assessment. HMRC applies the employment status tests to your working relationship.
The three key tests are: personal service (could someone else do the work?), control (does the client direct how, when, and where the work is done?), and mutuality of obligation (is the client obliged to offer work and the contractor obliged to accept?). If the reality suggests employment, HMRC issues a determination that IR35 applies.
Stage 4: Tax demand. HMRC calculates the PAYE and NICs that should have been deducted and issues a demand. Interest accrues from the date the tax should originally have been paid. Penalties may apply if HMRC concludes the company was careless or deliberate in its determination.
Stage 5: Appeal. You can appeal HMRC’s determination within 30 days. The appeal goes to the First-tier Tribunal (Tax). IR35 appeals are fact-intensive and the outcome depends on the specific working arrangements, not on generic contract terms.
The Financial Impact of an IR35 Ruling on Your Company
We are specific about the numbers because directors underestimate them:
- Employer NICs: 13.8% on the deemed employment income above the secondary threshold.
- Employee PAYE and NICs: the company becomes liable for the tax that should have been deducted at source.
- Interest: accrues from the original due date at the HMRC late payment rate (currently 7.5%).
- Penalties: 0 to 30% for careless errors, 20 to 70% for deliberate errors, 30 to 100% for deliberate concealment.
For a single contractor engaged at £100,000 per year over 3 years, a successful IR35 determination can produce a tax demand of £60,000 to £90,000 plus interest and penalties. If your company engages multiple contractors, multiply accordingly.
We have seen IR35 liabilities that exceeded the company’s total assets, pushing it into insolvency. If that happens, your question shifts from “how do we pay this?” to “can the company survive?”
How to Respond to an IR35 Investigation
- Do not ignore it. Non-response triggers an assessment based on HMRC’s assumptions, which will be worse than reality.
- Engage a specialist tax adviser immediately. IR35 is a specialist area. General accountants rarely have the expertise to defend an investigation effectively. We advise instructing a tax adviser with specific IR35 experience before responding to HMRC.
- Review the actual working arrangements, not just the contract. HMRC tests the reality, not the paperwork. If your contract says “right of substitution” but the contractor has never sent a substitute and the client would not accept one, the contract clause is meaningless.
- Prepare for the financial impact. If the determination goes against you, the tax demand arrives quickly. If the amount is large, speak to a licensed insolvency practitioner about whether the company can absorb it or whether Time to Pay or other options are needed.
- Consider whether to appeal. IR35 appeals are winnable; the tribunal overturns HMRC in a significant proportion of cases. But appeals are expensive and take 12 to 18 months. Balance the cost of appeal against the amount at stake.
Company Debt connects directors with licensed insolvency practitioners who can assess whether an IR35 liability threatens your company’s solvency and what options are available. A free, confidential consultation will clarify where you stand.
FAQs on HMRC IR35 Investigations
Who is liable if IR35 applies?
For engagements from April 2021 onwards (medium/large private sector), the fee-payer is liable, usually the company that paid the PSC. For pre-April 2021 engagements, the PSC itself is liable.
The contractor is not personally liable for employer NICs, but may face employee tax adjustments.
How far back can HMRC investigate IR35?
Four years for careless errors, six years for negligent errors, and twenty years for deliberate concealment. Most investigations cover 3 to 4 years of engagements. The longer the lookback period, the larger your potential liability.
Can I appeal an IR35 determination?
Yes. Appeal within 30 days to the First-tier Tribunal (Tax). IR35 appeals are fact-intensive and the tribunal overturns HMRC in a significant proportion of cases.
A specialist IR35 tax adviser is essential for a tribunal appeal.
Can an IR35 liability push my company into insolvency?
Yes. For companies that engaged multiple contractors, IR35 liabilities can run into six figures. If your company cannot absorb the tax demand, it may need a Time to Pay arrangement, a CVA, or, if the liability is too large, formal insolvency.
Seek insolvency advice as soon as you receive a significant IR35 determination.
