Limited company contractors must embrace, knowing about the ins and outs of IR35. If not, they have to face IR35 penalties. Contractors who are inside IR35 must pay tax at a significantly higher amount and National Insurance Contributions (NICS). This will result in a significant decrease in their net earnings.
However, contractors who understand that they are inside IR35 yet opt to hide it, or still are inside IR35 after an HRMC inspection, will face severe IR35 penalties.
HMRC’s way of penalizing contractors who are inside IR35
HRMC introduced a stricter system that penalized contractors doing IR35 misconduct. Prior to April 2009, the tax adviser of a contractor could negotiate with the liability of a contractor and decrease payments. The current system introduced the reminder that taxpayers must do reasonable care.
Contractors who under-declare their tax liability by not including their deemed payment of NICs or additional tax as a result of being inside IR35 will result in levy penalties by HRMC. Regardless of the reason why a contractor is inaccurate, these penalties still have to be paid.
If HRMC declares the contractor to have been careless, the penalty is 30% of the unpaid tax. On the other hand, if HRMC believes there is deliberate underpayment with the contractor knowing they were inside IR35 yet did not make the deemed payment calculation, the penalty is 70% of unpaid tax. Moreover, if the contractor knew they were inside IR35, did not calculate the deemed payment, and tried to hide the underpayment, the contractor will pay 100% of the unpaid tax.
Deemed payment: an IR35 penalty
The ‘deemed payment’ rules of IR35 shows that contractors can pay up to 25% more tax and NICs if their contract is inside IR35 and they are found to be a disguised employee. HRCM rules permit a 5% allowance for expenses and the rest proceeds to the gross earnings of the contractor for the contract inside IR35 subject to NICs and income tax. This results in contractors being seriously penalized.
It is significant to note that the extra tax calculated that falls under the deemed payment is less than not declaring IR35status.
Contractor’s duty to perform ‘reasonable care’
IR35 requires taxpayers to conduct reasonable care. This phrase reasonable care is dependent on the person himself, his circumstances, and his abilities. However, everyone is expected to create and keep sufficient records to provide a complete and accurate return.
HRMC declares that a taxpayer demonstrated reasonable care when he is verifying his correct position despite him not understanding anything. A contractor demonstrates reasonable care when he opts to undergo an IR35 contract review for each assignment.
IR35 penalties are expensive, stressful, and time-consuming for contractors. This worsens if the case is brought to the courts and tax tribunal.
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