Your limited company has received an HMRC discovery letter. What do you do first?
Q: What steps should I take if I receive a “discovery” letter from HMRC as a limited company freelancer who does not work through a recruitment agency, umbrella or payroll company?
A: A discovery assessment, most likely for the 2017/18 tax year (or an accounting period ending in that tax year), will be issued to the taxable entity that HMRC considers to have underpaid tax. That may be you as an Individual or your company. Sometimes both since HMRC claims that they can issue these assessments on a protective basis.
If you (and/or your company) receive one, you have 30 days to appeal. That appeal should contain suitable grounds as to why you think the assessment is incorrect or excessive. Usually, you would also ask for a postponement of the tax claimed as due. (Be warned that because HMRC sends notice of the tax due to Debt Management upon issue of the assessment, a late appeal may result in Debt Management chasing the alleged sum outstanding before the postponement can be actioned).
If you have an agent, show them the material from HMRC even if you think they have a copy.
Once the appeal has been made you need to turn your attention to how you wish to resolve the assessment. Your choices are either to settle (i.e. pay the amount demanded after perhaps correcting any errors in quantum) or challenge HMRC’s view of liability.
For most contractors that inevitably ends in litigation and the only question is when. If the liability is based on an arrangement that is already in Tribunal or Court, then a resolution in a year is possible. If not, then perhaps three to five years to resolve this.
In general the cost of defending a tax assessment arising from an enquiry is not allowable as a business expense. The allowable costs are those that relate directly to that business earning income or trading.
Whilst non-compliance with tax laws can impact a business (or even close it), tax is not a business expense. It is a consequence of earning profits.
It follows that the cost of defending a tax enquiry is not a business expense either.
So, when large companies have to go to court over tax issues, who pays the legal bills? The directors of the company?
The company will pay the bills but will not be able to claim a tax deduction for them.
Also, if a contractor goes to get IR35 insurance and/or an IR35/Off Payroll contract assessment would a contractor/freelancer be able to claim those costs as an expense on their business if they are either a limited company or sole trader? The reason I ask is that these companies represent contractors in tribunals I believe?
A far trickier question. Strictly I would say that the costs do not qualify for tax relief. I suspect however that such costs are routinely claimed and allowed in the absence of any enquiry from HMRC. I could make a case for such costs being allowed but if HMRC wanted to make it an issue, all case law is on their side.
The businesses offering such insurance are running a business of responding to tax enquiries and as such their costs are tax-deductible.
I would observe that very few cases involving “ordinary” contractors actually reach Tribunal and that cases involving such individuals in the past are few and far between. I would therefore question the use of such “insurance” especially now that the IR35 decision (inside or outside) actually lies with the end-user and not the individual.