Tax investigations can be incredibly costly, with various elements adding up to create a financial headache for small business owners.
We explain where the different fees can come from, and how your business can protect itself from running into financial difficulty as a result of a tax investigation.
While it might not seem like a financial cost at first, a tax investigation can eat up a large portion of your time which will have a cost implication.
You will often be called upon to provide additional information during the investigation, working alongside accountants and other financial specialists to respond to requests. Completing these tasks can keep you away from your business.
If you’re part of a small team of salespeople or a sole trader for example, this could severely hamper your business and your ability to work - your ability to sell, offer services to customers and, ultimately, make money.
Putting steps in place to help protect your business can help you get through this process smoothly and help to keep your business afloat during a tax investigation.
A tax investigation is carried out to calculate if you owe any money to HMRC and how much that is. That repayment can vary depending on the findings of the investigation.
You should also be aware that any repayments you make could be subject to additional fines – especially if the errors in your original tax return were found to be avoidable or deliberately misleading.
Penalties are based on the reason for the error occurring, such as late or inaccurate payments. More serious reasons can incur a much higher penalty.
For example, if you have provided a tax return that contains a deliberate error, you could be asked to pay a penalty that ranges between 20 and 70% of the extra tax you are required to pay.
This is why accuracy is so important when reporting your finances. Should you owe a large amount in back taxes, then be required to pay a large additional penalty on top of that, because of providing inaccurate information, this could potentially cause problems with your business’s finances.
On top of back pay and penalty fees, you should also take into consideration the additional cost of getting help to deal with your tax investigation.
You might need a specialist to help you work through financial issues in a certain area. This could include a VAT specialist to help you calculate whether you made accurate payments or not.
You should also factor in the general accountancy bills that might build up through the investigation. In some cases, these additional fees can be significantly more than the amount you’re being asked to pay HMRC.
These additional fees, penalties and back payments can mean that your business stands to take a significant financial hit at some point. This can cause a great deal of stress, especially in a lengthy investigation where you’re waiting on a final fee from HMRC, all the while utilising an accountant who has on-going fees to be paid.
earnings from employment, including benefits in kind such as a company car
earnings from self-employment
most pensions income, including state, occupational and personal pensions
some social security benefits
interest on most savings
income from shares (dividends)
income from a trust
You won't usually have to pay tax on all your income, even if it's all taxable, because you'll be entitled to a certain amount of income tax free every tax year. The tax year runs from 6 April one year to 5 April the following year.
There's no minimum age when you have to start paying income tax. What matters is the amount of your taxable income. If this is below a certain level, no tax is payable.
Check how much income tax you'll pay
You can estimate your income tax for the current tax year on GOV.UK. You can’t use the calculator if you’re repaying a student loan or contributing to a pension through your employer.
There are other online calculators you can use to estimate your income tax if you’re repaying a student loan or contributing to a pension. They include:
HM Revenue and Customs Taxes Helpline Tel: 0300 200 3300 (Monday to Friday from 8.00am to 8.00pm; Saturday from 8.00am to 4.00pm) Textphone: 0300 200 3319
Calls usually cost up to 40p a minute from mobiles and up to 10p a minute from landlines. It should be free if you have a contract that includes calls to landlines - check with your supplier if you’re not sure.
Income that's not taxable
Some income is not taxable, which means you don't have to pay tax on it - for example, Housing Benefit, Child Benefit and lottery winnings. The government ignores this income when working out how much tax you have to pay.
Paying tax on foreign income
You might need to pay UK income tax on foreign income, for example:
wages if you work abroad
foreign investments and savings interest
rental income on overseas property
income from pensions held overseas
Foreign income is anything from outside England, Scotland, Wales and Northern Ireland. The Channel Islands and the Isle of Man are classed as foreign.
Whether you need to pay depends on if you’re classed as resident in the UK for tax. If you’re not a UK resident, you won’t have to pay UK tax on your foreign income. If you’re a UK resident, you’ll normally pay tax on your foreign income. But you may not have to if your permanent home (domicile) is abroad.
Your Personal Allowance may be bigger if you’re entitled to Marriage Allowance or Blind Person's Allowance. If you earn more than £100,000 a year, your Personal Allowance is smaller.
Read more about Marriage Allowance and Blind Person's Allowance.
If you're an employee or pensioner who pays tax through the Pay As You Earn (PAYE) scheme, your personal allowance will be spread throughout the year. This means every week or month you’ll have a certain amount of tax-free income and pay tax on the rest.
If you’re self-employed or have other taxable income not taxed through PAYE, your personal allowances will be taken into account when your tax bill is calculated. Your tax bill is calculated after you submit your annual tax return or repayment claim.
You don’t have to pay income tax on some work-related expenses - for example, if you need to spend money on uniforms or travel for work. This is called ‘tax relief’.
Your tax relief is applied in the same way as your personal allowances. If you’re employed, your tax relief is spread throughout the year. If you’re self-employed, or you have other taxable income, your tax relief is taken into account when your tax bill is calculated. Your tax bill is calculated after you submit your annual tax return or repayment claim.
When you're calculating how much income tax you need to pay, you’ll need to work out if you’ve received any income where the tax has already been paid. Your employer should have already deducted tax from the wages or workplace pension payments you get.
When the government calculates your total taxable income, they deduct your personal allowances and tax relief from your ‘gross income’. This is the amount you received before tax. So when you're working out the total tax you need to pay for the year, make sure you take into account if you've already paid tax on your income.
As well as checking you’re paying the right amount of income tax, you might want to check you’re paying the correct amount of National Insurance contributions. National Insurance contributions are calculated on gross pay - this is your total pay before tax. If you’re employed, the amount of National Insurance you pay depends on the amount you earn and your pension arrangements.
If you’re self-employed, you pay National Insurance contributions at different rates depending on your profits.
If you have to do a Self Assessment tax return, you must legally keep a record of your income and any expenses you claim against tax. You’ll need these records if HMRC asks you to complete a tax return.
How Income Tax, National Insurance and the Personal Allowance works
Unsure about Income Tax and National Insurance?Don’t know what the National Insurance threshold is?Unsure how the Personal Allowance applies to you?We explain how the tax system works and what to do if you think you’re overpaying.
Should I pay any Income Tax?
The Personal Allowance if you earn over £100,000
What is Income Tax used for?
How much Income Tax will I pay?
What do you pay National Insurance on?
Voluntary ‘Class 3’ National Insurance rates
Voluntary ‘Class 2’ National Insurance rates
Should I pay any Income Tax?
Income Tax is charged on most types of income, such as wages and salary from jobs, your profits if you run a business, pensions, rents you receive if you’re a landlord, and interest and dividends from savings and investments.?
Got a question?
Our advisers will point you in the right direction.
You don’t usually pay Income Tax on all of your taxable income. This is because most people qualify for one or more allowances. An allowance is an amount of otherwise taxable income that you can have tax-free each tax year.
1 Reduced by £1 for every £2 above income threshold until it reaches £0.
2 20% of this allowance is given as a reduction in your tax bill (unlike the Personal Allowance and Age Allowance which are deducted from your taxable income before tax is worked out).
3 £1,000 for basic-rate taxpayers; £500 for higher-rate taxpayers; £0 for additional-rate taxpayers.
Most allowances are increased each year and increases apply from the start of the tax year, 6 April.
Jump down to ‘How much Income Tax will I pay?’ to find out what you’re liable for.
What is a Personal Allowance?
Everyone, including students, has something called a Personal Allowance – the amount of money you’re allowed to earn each tax year before you pay Income Tax. Your Personal Allowance may be bigger if you claim Marriage Allowance or Blind Person’s Allowance, or smaller depending on your income or if you owe tax from a previous tax year.
The tax year runs from 6 April to 5 April, and for the 2019-20 tax year the standard Personal Allowance is £12,500. The Personal Allowance will also be set at £12,500 for 2020/21 tax year and then indexed with the Consumer Price Index (CPI) from then onwards.
If you earn less than this, you normally shouldn’t have to pay any Income Tax.
The amount of the Personal Allowance you receive is set by the government and can change from one tax year to the next.Check the most up-to-date Personal Allowance figures on GOV.UK.
The Personal Allowance if you earn over £100,000
For people earning over £100,000, the figure of £12,500 will be reduced by £1 for every £2 earnt. When someone earns £125,000 Income Tax is paid on everything earnt and there’s no tax-free allowance.
What is Income Tax used for?
Your Personal Allowance is taken off your earnings before you start paying Income Tax.
Income Tax is collected by HMRC on behalf of the government. It’s used to help provide funding for public services such as the NHS, education and the welfare system, as well as investment in public projects, such as roads, rail and housing.
How much Income Tax will I pay?
From April 2019, the standard Personal Allowance will increase to £12,500, with the higher rate tax threshold increasing to £50,000.
Income Tax is made up of different bands. This means that as your income increases so too does the amount of Income Tax you pay.
It’s an attempt to make paying Income Tax as fair as possible so that those who earn the most contribute more.
The table below shows the rates of Income Tax depending on how much you earn.
If you live in Wales, income tax rates are now set by the Welsh Government. These are currently the same as for England and Northern Ireland in the 2019/20 tax year. If you live in Scotland, the rates are different.
If you think you might have had Income Tax wrongly taken from your earnings, fill in the form from Her Majesty’s Revenue and Customs (HMRC) to have it paid back to you.Get the R38 form to reclaim tax on GOV.UK, or contact HMRC.
National Insurance contributions are a tax on earnings paid by employees and employers and help to build your entitlement to certain state benefits, such as the State Pension and Maternity Allowance.
Unlike Income Tax, National Insurance is not an annual tax. It applies to your pay each pay period (which might be monthly, weekly or some other period depending on your employer’s arrangements). This means if you earn extra in one month, you’ll pay extra National Insurance, but you won’t be able to claim the extra back even if your pay is lower during the other months of the tax year.
You begin paying National Insurance once you earn more than £166 a week (this is the figure for the 2019-20 tax year).
The National Insurance rate you pay depends on how much you earn:
12% of your weekly earnings between £166 and £962
2% of your weekly earnings above £962.
Your National Insurance contributions will be taken off along with Income Tax before your employer pays your wages.
Until April 1977, some older married women and widows who pay National Insurance contributions at the Married Women’s Reduced Rate could choose to pay a reduced rate of national insurance. You might still be paying the reduced rate if you opted for this before the scheme ended. The reduced rate is 5.85% of weekly earnings between £166 and £962 instead of the standard rate of National Insurance of 12% on earnings. As a result, your State Pension could be reduced and your ability to claim some contribution-based benefits could be negatively impacted.
Both you and your employer must pay National Insurance contributions on your earnings – including holiday pay, sick pay and maternity pay – and, in most cases, any reward you get that can be easily converted to cash. But there are exceptions – for example, if part of your pay is shares in your employer’s company using a tax-approved share scheme.
Part of your pay may be in the form of benefits in kind. As an employee, there is no National Insurance on benefits in kind. However, with some exceptions, employers do have to pay National Insurance on the value of any benefits in kind that they provide you with.
What do National Insurance payments pay for?
Your National Insurance payments go towards state benefits and services, including:
the State Pension
sickness and disability allowances.
Voluntary ‘Class 3’ National Insurance rates
Class 3 voluntary National Insurance contributions are designed to fill in any gaps in your National Insurance record to get a higher State Pension.
To receive the full new State Pension, which is payable to people who have reached their State Pension age on or after 6 April 2016, you’ll need to have 35 qualifying years of National Insurance contributions.
Anyone with less than this will receive a reduced State Pension. To receive the new State Pension you need to have a minimum of 10 qualifying years.
If you don’t have 35 qualifying years, you may want to consider paying Class 3 voluntary contributions to boost your pension entitlement.
In 2019-20, Class 3 contributions are payable at a weekly rate of £15. This is the maximum you can pay each week.
If you’re self-employed or have been working abroad, you may be able to pay voluntary Class 2 contributions instead.
Class 2 NICs are currently flat-rate weekly contributions of £3.00 per week in 2019-20. You’ll need to pay them for every week or partial week of self-employment in a tax year if your profits for the entire tax year are £8,632 (the Small Profits Threshold) or more in 2019-20.
Payment of Class 2 contributions is voluntary for self-employed people with profits below the Small Profits Threshold. Paying Class 2 NICs even if your profits are lower can still help you build contributory entitlements to benefits.
This can be a specialist area and it’s best to take advice based on your individual personal circumstances.
The government has reaffirmed plans to make changes to off-payroll working (IR35) rules effective from 6th April 2020. This will affect any contractors working through a Personal Service Company, Recruitment Agencies, and all Large and Medium-sized end clients.
The final contents of the Finance Bill will be confirmed by the Chancellor of the Exchequer as part of the government’s 2019 Budget. The off-payroll working changes are due to take effect from 6th April 2020 and are summarised in the sections below.
Summary of changes to IR35 due to be implemented in 6th April 2020:
There are a number of changes due to be implemented in April 2020, these will have impacts on end-clients, recruiters, and contractors working through limited companies. We’ve summarised the main changes and impacts below.
The end-client is now responsible for determining whether a contract is inside or outside of IR35 rules
The changes for the private sector mean the end-client is now responsible for determining the IR35 status of a contract with a Personal Service Company (PSC). The rules will be consistent with the changes brought in for the public sector in April 2017.
Small business exemption to new IR35 rules
The legislation applies only to ‘medium or large’ businesses. There’s an exemption for end-clients who are ‘small businesses’ as defined by the Companies Act 2006 which means meeting two or more of the following criteria:
Annual turnover is no more than £10.2 million
Balance sheet total is no more than £5.1 million
No more than 50 employees.
Where the end-client meets two or more of these criteria, responsibility for determining the IR35 status of a contract remains with the PSC and the changes do not apply.
The government has included clauses in the legislation to ensure medium or large businesses do not set-up arm’s length companies or subsidiaries to procure services from PSCs. The legislation will apply to the parent company based on the aggregate amount of turnover and the aggregate amount of the balance sheet total of the connected entities.
There’s no small business exemption for public sector organisations and the legislation will apply to all end-clients engaging PSC workers in the public sector.
IR35 Status Determination Statement (SDS)
The end-client must confirm the IR35 status of a contract by providing a ‘Status Determination Statement’ (SDS). The SDS must be provided in writing to the PSC worker and, if an Agency is involved in the labour supply chain, a copy must be provided to the Agency responsible for paying the PSC.
These arrangements place most of the responsibility for administering an SDS on the end-client and/or the fee payer (if an Agency is involved).
IR35 status dispute resolution process is led by the end-client
It’s the responsibility of the end-client to establish arrangements to consider any disputes from PSCs about the SDS. The legislation does not specify how such arrangements should work in practice but does state a time limit of 45 days to respond, in writing, to the PSC with the outcome of the review of the dispute.
The decision must either confirm the original SDS is upheld, or, if it involves a revised SDS or conclusion, a new SDS must be provided in line with the arrangements outlined above.
Transfer of employment tax liabilities to another relevant person
The legislation is designed to ensure the organisation with responsibility for issuing the SDS, or the fee-payer if an Agency is involved, is responsible for any employment tax liabilities arising.
The legislation also allows HMRC to recover tax liabilities from another ‘relevant person’. A relevant person is any party involved in the payment to a PSC. This means HMRC can recover tax from the highest party in the labour supply chain which is not complying with the legislation. HMRC believes this will ensure compliance with the rules across all parties involved in the labour supply chain.
5% administration allowance withdrawn (mostly)
As expected, the draft legislation removes the 5% allowance for PSCs to meet the costs of administering the off-payroll working rules. The allowance will continue for PSCs working with ‘small’ end-clients as defined above.
Check of Employment Status Tool (CEST)
The government recognises the Check of Employment Status Tool (CEST) needs to be strengthened. It’s expected that a further announcement will be made when further guidance and support for businesses is published throughout 2019.
Conclusion – The new IR35 rules will cause issues
Cloud Accounting NI responded to the government’s consultation earlier in the year. It’s disappointing that most of the issues raised by us, and other responders, have been largely ignored in the draft legislation. Of particular concern remains the:
errors and inconsistencies contained in the government’s online Check of Employment Status Tool (CEST)
additional investment required to complete an employment status determination by an end-client on a contract by contract basis
removal of the 5% allowance for PSCs to administer off-payroll working rules
risks to PSCs from the dispute resolution process which are the responsibility of the end-client to administer.
The IR35 'off-payroll' rules will be extended to the private sector from April 2020 onwards, directly affecting a large number of contractors.
Therefore there has never been a more important time to review your business for IR35 and take action if it is affected.
As a Limited Company Contractor or Sole Trader, IR35 is an important consideration for you as it sets out the law relating to tax treatment of your income and also determines your tax position with HMRC. Contractors that fall outside IR35 legislation are entitled to receive payment in the form of dividends. Those who fall inside IR35 are seen as a disguised employee and are only entitled to receive payment on a PAYE basis (albeit through their Limited Company).
Therefore, being caught by IR35 does not prevent you from working through your company, it just means that you need to tax yourself differently with the assignment which is within IR35.
In order to determine if an individual is likely to be caught by IR35, the following series of questions provide a clearer picture as to whether a worker is deemed to be an employee or self-employed. If the majority of answers to the following questions is ‘Yes’, the more likely an individual is to fall inside IR35 and therefore a ‘disguised employee’ of the end client:
Do you have to do the work yourselves?
Can someone tell you at any time what to do, where to carry out the work or when and how to do the work?
Do you have to work a set amount of hours?
Can someone move you from task to task?
Do you receive overtime pay or bonus payment?
It is important to reiterate that these questions do not set an individual’s IR35 status in stone but do provide a clearer picture with HMRC as to how an individual works. Cloud Accounting LLP offers unlimited IR35 checks when working through a limited company to make sure you operate compliantly.
If you answered yes to one or more questions, please contact us to see how switching to Cloud Accounting LLP can help you with how to avoid IR35.
THE FOLLOWING TIPS WILL HELP DEMONSTRATE YOU’RE NOT A DISGUISED EMPLOYEE ONSITE AND CAUGHT BY IR35.
1. ENSURE YOUR CONTRACTS ARE ACCURATE AND CONSISTENT
It makes little sense having a contract that states that you will be subject to the control of the client, or that the client’s processes and procedures will apply to you when they don’t in practice. Also, make sure that the contract between the agency and the client does not contain anything that contradicts your contract with your agency.
2. MAKE SURE YOUR CLIENT THINKS THE SAME WAY YOU DO
If your client sees you as an extension of its own workforce, the company is more likely to treat you as an employee. Make sure they know that you are contracted for a specific reason and that they treat you as independent of their organisation throughout your assignment.
3.ENSURE THAT THE CLIENT’S REPRESENTATIVE VIEWS YOU AS AN INDEPENDENT CONSULTANT
This is particularly important where your client representative (i.e. The person who would liaise with HMRC in the event of an IR35 enquiry) is different from the individual who hired your services or worked with you day to day at the outset of the project. If necessary, provide a copy of your contract to the client representative or even a “statement of understanding” which sets out how you intend to work/be treated whilst on an assignment with the client to avoid any misunderstandings.
4.DEMONSTRATE THAT YOU ARE TREATED DIFFERENTLY FROM YOUR CLIENT’S EMPLOYEES
Genuine employees will have certain set working conditions, such as minimum hours, pension arrangements and other benefits, and perhaps subsidised services too. The employer also has a duty to provide work for them, which the employee has an obligation to do – and the employer can stipulate where and how the work is to be carried out. You should be able to show that little if any of this applies to you.
Different pay and benefits will not be enough on their own. Flexible working, assignments for other clients, bring your own equipment, working on a specific package of work for a fixed fee and/or a fixed period are all good ways of showing that you are truly independent.
5. WORKING AS PART OF A TEAM DOES NOT AUTOMATICALLY RENDER YOU A DISGUISED EMPLOYEE OF THE CLIENT
It is essential, however, that you agree to the scope of the work you undertake at the outset of the assignment. Being continually allocated further work by the client, particularly without putting in place additional contracts, could show that you are being treated as an employee. If further work comes up, make sure you put a contract in place before you start working on it.
6. PROVIDE A SUBSTITUTE
Not only does providing a substitute give unequivocal evidence that you are not obliged to offer a personal service, and therefore cannot be a disguised employee, it can also enable you to profit further from the assignment by supplying cheaper labour to perform the services on your behalf. It could also give you the flexibility to work on another contract with a different client.
Having a substitute ready to engage on a project is a strong signal you are running a business. These "employees" can be set up on a zero hours contract. You may want to have arrangements to join a group of fellow experts in your industry niche and make reciprocal zero hours contract arrangements to step into each others project in when necessary - eg if you took ill health, during holidays etc.
7. PROJECT-BASED ASSIGNMENTS ARE SIGNIFICANTLY BETTER THAN PERIOD BASED ONES
Being engaged on a specific project enables you to quote a fixed fee and work flexibly as long as deadlines and project completion dates are met. Being engaged on an ongoing basis may suggest you are only there until the client recruits a permanent employee to do your job. This may indicate that the company is treating you as if you were that individual until someone permanent comes along which can potentially make you a disguised employee.
8. MANAGE YOUR OWN ASSIGNMENTS
As an independent contractor, you should determine the hours required to complete the work. It is important that you take control over managing your assignments and don’t rely on being allocated work. This should also enable you to quote a fixed fee for the project and/or undertake work for other customers alongside your assignments.
9. CALLING YOURSELF A CONTRACTOR AND NOT RECEIVING HOLIDAY OR SICK PAY IS NOT ENOUGH TO PROVE THAT YOU ARE NOT AN EMPLOYEE OF THE CLIENT
Your working practices and other terms of the contract must indicate that you are self-employed. This could involve you showing that you have financial risk in terms of bad debts, rectifying work at your own cost and investing in your company, all good ‘badges of trade’.
10. WORKING FOR MULTIPLE CLIENTS AND INVESTING IN YOUR OWN COMPANY IS A GOOD WAY OF DEMONSTRATING THAT YOU ARE IN BUSINESS OF YOUR OWN ACCOUNT
The more clients you work for, the easier it is to demonstrate that you are self-employed, whereas only having one client as your sole source of income for a lengthy period of time may suggest that you are employed by the end client. To counteract this, pay for your own training and provide as much of your own equipment as possible and pay for them through your business to ensure they are properly accounted for.
HERE ARE SOME PRACTICAL CONSIDERATIONS:
1. Keep client correspondence
If you have emails that clearly state you are not under the control of a manager at the business, but are simply contracted to provide a service, this can be useful too.
2. Don’t name your company after yourself
HMRC knows that a company named after a person may well be just that person, and this fits their profile of a PSC. But if your company has a more ‘business-like’ name, e.g. XYZ Design, it emphasises the fact that your company is distinct from you, and that you could delegate the work to another person if necessary. Employees cannot delegate in this way, so it marks you out as different.
3. Have your own marketing materials
You should be able to demonstrate that you market your contracting services actively. Have a listing on relevant services website, post adverts and print business cards, all of which help to indicate that you are in business on your own account. Never use a business card which includes your client’s branding!
4. Maintain your own office
A well-equipped office, even just in your own home, will strongly imply that your work activities extend well beyond your current client. If you also invest in your own software licences, trade literature and professional memberships, this can help a great deal too.
6. Take out your own business insurance
Having your own business insurance, such as professional indemnity insurance, is a great way of demonstrating that you’re not just an employee.
7. Invest in your professional development
Employees don’t pay for their own training, so if you pay for yours this will be another useful point of difference. Some professions may require you to take continued professional development (CPD) to remain qualified, so by paying for this you’re also reasserting your contractor status.
8. Try to have multiple clients at the same time
It’s not always possible to arrange, but if your time is split fairly evenly between two or more main clients, it’s much harder for HMRC to claim you’re an employee of any of them. However, having a very uneven split (e.g. 90 per cent of your income deriving from one client) may be less convincing.
The more of these strands of evidence you can call upon, the more likely it is that HMRC will accept you are in business on your own account. Having just one or two on their own may not be enough.
Get in touch with us and we can help you calculate how much you might owe if you fall within IR35.
Potentially being classed as a disguised employee can seem like a confusing scenario but it doesn’t have to be.
Over the last 10 years, Cloud Accounting LLP have helped many contractors, freelancers and self-employed professionals, just like you to save time, money and hassle with our comprehensive range of accountancy, financial, legal, insurance and business services.
Cloud Accounting LLP can help you with the responsibility for determining if IR35 applies and assist you with any concerns you may have about potentially disguised employment. Please get in touch to find out more about how we can help you.
Necessary cookies are absolutely essential for the website to function properly. This category only includes cookies that ensures basic functionalities and security features of the website. These cookies do not store any personal information.