Avoiding penalties during an HMRC IR35 check is essential for contractors, end clients, and agencies operating within the UK’s off-payroll working rules. IR35 legislation is designed to ensure that contractors who work like employees pay the correct tax. However, the rules can be complex, and HMRC takes compliance seriously. When an IR35 check is triggered, businesses and contractors must be prepared to demonstrate that they have followed the rules correctly. Failing to do so can result in significant penalties, interest charges, and backdated tax liabilities. Understanding how to avoid these penalties begins with knowing what HMRC looks for, how investigations unfold, and what steps can keep your business or contract safe.

An HMRC IR35 check typically starts when HMRC suspects that a contractor might be working as a disguised employee or that a business has failed to assess employment status accurately. These checks involve reviewing contracts, working practices, communication, and financial evidence. Avoiding penalties requires demonstrating that you have taken reasonable care to comply with IR35 rules. Reasonable care is a key theme in HMRC guidance. If HMRC believes you did not take reasonable care when determining IR35 status, penalties can increase significantly. Therefore, good practice, strong documentation, and consistent compliance measures are essential.

One of the most effective ways to avoid penalties during an IR35 check is to ensure that contracts accurately reflect real working practices. HMRC places more weight on what happens day-to-day than what is written in the contract. If a contract states that a contractor has control over their work, but in practice the client dictates hours, methods, or processes, HMRC will consider the working arrangement more like employment. Ensuring written agreements and actual working behaviour match is essential to reducing IR35 risk. Contractors should regularly review their contracts with their clients to make sure they remain accurate throughout the engagement.

Another critical factor is control. HMRC examines whether the contractor has autonomy over how, when, and where they work. If the client exercises significant control, such as dictating schedules, approving methods, or requiring close supervision, the contractor may appear to be inside IR35. To reduce the risk of penalties, contractors and clients should ensure working arrangements are consistent with a genuinely independent service provider. Examples include agreeing deliverables instead of hours, working off-site when possible, and showing clear independence in decision-making.

Substitution is another major IR35 test. A genuine right of substitution means the contractor can send someone else to complete the work, which suggests self-employment. If the contract includes a substitution clause but the client would never realistically allow a substitute, HMRC may disregard the clause. To avoid penalties, this right should be genuine, practical, and acceptable to the client. Even if the contractor never uses a substitute, the ability to do so strengthens their position. Keeping documentation related to substitution rights, such as client acceptance statements, strengthens your defence during an IR35 check.

Mutuality of Obligation (MOO) is another area HMRC examines closely. A normal employment relationship involves mutual obligations: the employer must provide work, and the worker must accept it. In contrast, contractors typically work on a project-by-project basis, with no ongoing obligation to provide or accept work. To avoid penalties during an IR35 review, contractors should avoid patterns that resemble permanent employment. Examples include continuous work without breaks, regular hours set by the client, and a long-term expectation to continue providing services. Structuring engagements with clear project scopes and defined deliverables helps demonstrate genuine self-employment.

Maintaining clear evidence of financial risk also helps avoid penalties. Employees generally face little financial risk, while contractors typically absorb business risks such as covering their own expenses or correcting mistakes without additional pay. To demonstrate financial risk, contractors should retain evidence of purchasing their own equipment, investing in business insurance, or absorbing costs when work needs correcting. This shows HMRC that the contractor operates as a genuine business, not an employee in disguise.

Good record-keeping is essential for avoiding penalties during an IR35 check. HMRC will review communication, invoices, contracts, project briefs, and working practice evidence. Poor documentation can lead to assumptions in HMRC’s favour. Contractors and businesses should keep emails, change requests, schedules, and updates that show how work was delivered. Maintaining clear financial records is also vital. HMRC expects contractors to store documentation for at least six years. The Infinity Group helps businesses and contractors organise and maintain IR35-compliant records, reducing the risk of penalties during an investigation.

Using HMRC’s CEST tool or independent IR35 assessments is another important defence. HMRC expects businesses to take reasonable care when determining employment status for tax purposes, especially under the off-payroll rules introduced in 2021 for medium and large companies. Using CEST, or having the engagement professionally reviewed, demonstrates reasonable care. If HMRC later disagrees with the assessment, penalties may be reduced or removed because the business took responsible steps. The Infinity Group provides professional IR35 reviews that help organisations ensure their determinations are robust and well documented.

Communication between the contractor and client must be consistent, accurate, and in line with the contract. HMRC sometimes interviews both parties during an IR35 check. If their answers do not align, it raises suspicion. To avoid penalties, contractors should discuss working practices with clients when a contract is signed and when it changes. Any updates should be documented in writing. Clear communication reduces misunderstandings and strengthens your position during an investigation.

Businesses and contractors should also avoid becoming too integrated into the client’s organisation. Integration is a sign of employment. If a contractor attends staff meetings, uses internal systems like an employee, or receives benefits that employees receive, HMRC may classify the relationship as employment. Contractors should keep boundaries clear. They should position themselves as external specialists, not part of the internal structure of the client. Evidence supporting this separation can be invaluable during an IR35 check.

Another important step to avoid penalties is preparing for compliance at the start of every engagement rather than reacting later. Proactive compliance means reviewing contracts before signing them, regularly assessing IR35 status, updating documentation, and ensuring working practices stay consistent. Waiting for an HMRC check to make improvements is risky and often too late. Businesses with multiple contractors should implement a formal IR35 compliance process that includes training, regular audits, and documented assessments. This demonstrates reasonable care and significantly reduces exposure to penalties.

For end clients, understanding liability under current IR35 rules is essential. Since 2021, medium and large businesses are responsible for determining IR35 status and may be liable for unpaid tax if they get it wrong. Clients should therefore maintain detailed Status Determination Statements (SDS), share them with contractors, and have a disagreement process in place. The Infinity Group assists businesses with these obligations by offering structured compliance frameworks and professional assessments.

In cases where HMRC starts an IR35 investigation, responding quickly and accurately is essential. Delayed responses or incomplete explanations can increase suspicion. Contractors and clients should gather all relevant records, ensure communication is factual, and seek advice from professionals who specialise in IR35 compliance. A prepared and organised response reduces the likelihood of escalating penalties.

In conclusion, avoiding penalties during an HMRC IR35 check requires clear evidence of compliance, consistent working practices, strong documentation, and reasonable care in every aspect of engagement. Contractors and businesses must understand control, substitution, mutuality of obligation, financial risk, and integration to demonstrate genuine self-employment. By maintaining accurate records, using formal assessments, aligning contracts with real working practices, and preparing early, businesses can significantly reduce the risk of penalties. For those seeking expert support, The Infinity Group provides professional IR35 compliance services that help contractors and organisations stay protected, confident, and fully prepared for any HMRC IR35 check.