How long are you at risk from a Revenue challenge?

Recent events such as the announcement of IR591 seem to have created a surge in the number of queries I get about the risks of an Inland Revenue challenge, particularly from freelancers who are planning to close down their business and question if they need to maintain ongoing protection or insurance. These have revealed a number of common misconceptions or areas which need clarification so I thought it might help to cover some of these in a short article.

I have or will close my company down. Will I still be at risk from the Revenue?

In all likelihood the risk from the Revenue could be even greater! The process of closing the company down usually involves obtaining the Revenue’s agreement to paying out the company’s reserves as a capital distribution.

Asking for this clearance may well trigger a final employer’s compliance review that will include IR35 as part of its remit. Even after a company has been closed down the Revenue can still launch a compliance audit or an investigation. In theory an investigation can be launched up to six years after closure, though it is more likely that it will be within a year of the due date for the last tax return of the company.

I bought tax investigation insurance for the years from April 2000, when IR35 started, until my company closed in 2003. Will I be covered now for an investigation into those years?

This depends on your insurance policy. However most professional fees, legal expense or tax investigation policies are written on a claims made basis as opposed to a claims incurred basis.

What does this mean? Simply put it means that the insurance is on the basis that you are covered for any investigation that is notified to you while you hold a valid policy, regardless of what period the investigation covers. This differs from the ‘claims incurred’ basis, which covers you for any claims relating to events that happened during a period that you held a valid insurance policy.

This is the basis that Employers Liability insurance works on – hence the need to retain old Employers Liability insurance certificates for 20 years after they have expired.

The reason most tax expense policies are written on the claims made basis is that insurers do not want the threat of a claim hanging over them for up to six years – it means they cannot easily work out if they have made an underwriting profit until this long tail period has elapsed.

The practical implication of this is that you must have a valid policy at the time the investigation starts and, if you do, then most policies will cover you regardless of whether the investigation covers a period that predates you taking the insurance out.

So if you fail to renew a policy that expires at 31 March 2004 and the Revenue launch an investigation into your affairs for the tax year 2003/4 in April 2004, then you are not covered.

But if you buy a policy on 6 April 2004 and the Revenue come knocking at your door a week later then you are covered even though the investigation will relate entirely to tax years prior to you buying the insurance (subject to the usual exclusions).

What about the impact of the Budget?

The Treasury has trailed that something is coming down the road at owner managed businesses by way of IR591 in the Budget (March 17). But the details will not be known until then.

One school of thought is that IR591 will spell the end of IR35 but I know of no-one who thinks the 'grass will be greener' for freelancers. If you are very optimistic you might take this view! However you need to bear a few things in mind, such as:

• Tax investigations occurred before IR35 was even thought of and they will still occur even if IR35 disappears.
  
• IR591 may not mean the end of IR35 – it could well be in addition to rather than instead of IR35. My reasoning goes like this. IR591 will undoubtedly affect a much wider range of companies than the personal service companies that IR35 targeted. It is very unlikely that IR591 will be as punitive for these companies as IR35 was for those that it caught. Hence if IR591 were to replace IR35 those companies that would have been caught by IR35 will be dealt with less severely under IR591. Given all that the Government has said about the unfairness of disguised employees being able to reduce their tax burden unfairly it seems unlikely that the Government will willingly remove IR35 and replace it with a less severe regime. Hence, for those workers and their companies that would be caught by IR35 it seems likely that IR35 or something very similar will remain in place. I think IR591 will be reserved for other businesses that are not caught by IR35.
  
• Even if IR35 is repealed that will only be for periods starting after 5 April 2004. Companies and freelancers will still be subject to IR35 investigations up to and including their 2003/4 tax returns which are not due to be filed until 31/1/2005. The Revenue can launch an investigation into those returns any time up to 31/1/2006.

Conclusions

I still think companies and freelancers are well advised to retain their tax investigation insurance, even if they are planning to stop contracting in the near future.