The letter lands in your inbox or on your doormat. It is headed "Compliance Check" and it references your agency's payments to freelancers and contractors. Your stomach drops.
You are not alone. HMRC has been running more compliance checks on agencies specifically around freelancer payments, IR35 status determinations, and off-payroll working rules. They know that agencies rely heavily on freelance talent. They also know that misclassification is common.
Here is what you need to do, in order, from the moment that letter arrives.
What Exactly Is an HMRC Compliance Check?
A compliance check is not a criminal investigation. It is HMRC reviewing your records to check that you have reported and paid the right tax. For agencies, the focus is usually on whether freelancers should have been treated as employees for tax purposes, and whether PAYE and National Insurance should have been applied to their payments.
HMRC can open a compliance check for any tax period within the last four years (six years if they suspect careless behaviour, twenty if they suspect deliberate concealment). The check can cover corporation tax, VAT, PAYE, or all of them at once.
For agency freelancer payments specifically, HMRC is looking for a few common patterns:
- Freelancers who work exclusively for your agency for long periods
- Freelancers who are integrated into your team, using your equipment, and following your processes
- Freelancers who have no right of substitution (they cannot send someone else to do the work)
- Freelancers who are paid through their own limited company but behave like employees
If any of those patterns describe your freelancer arrangements, you need to take this seriously. Our ICAEW qualified team at Agency Founder Finance handles these checks regularly for agency founders.
Step One: Do Not Ignore the Letter
This sounds obvious, but you would be surprised how many founders put the letter in a drawer and hope it goes away. It will not. HMRC will escalate. They will issue information notices. They will estimate the tax due and charge you penalties on top.
You typically have 30 days to respond to the initial letter. Use that time wisely, but do not waste the first week paralysed.
Reply within seven days acknowledging receipt and confirming that you are gathering the requested information. That buys you goodwill and shows you are cooperating.
Step Two: Understand What HMRC Has Asked For
Read the letter carefully. HMRC will specify exactly what they want to see. Common requests for agency freelancer payment checks include:
- Details of all freelancers paid in the period under review
- Contracts between your agency and each freelancer
- Contracts between your agency and the end client (if you are a recruitment or staffing agency)
- Status Determination Statements (SDS) if you issued them
- Invoices from freelancers
- Bank statements showing payments to freelancers
- Details of any IR35 reviews you have carried out
Do not send everything you have. Send exactly what they asked for, no more. Extra information can create extra questions.
Step Three: Get Your Evidence in Order
This is where most agencies fall down. They have the contracts, but the contracts do not match reality. A contract might say the freelancer can send a substitute, but in practice the freelancer has always done the work themselves. HMRC will look at what actually happened, not what the contract says.
You need evidence of the working relationship, not just the legal paperwork. That means:
- Email chains showing how work was instructed and delivered
- Timesheets or project logs
- Records of who provided equipment (laptop, software licences, office space)
- Evidence of the freelancer working for other clients at the same time
- Records of the freelancer marketing their own services
If you are a digital agency or creative agency, you likely have project management tools (Asana, Trello, Monday.com) that show how freelancers interacted with your team. Export those records. They are powerful evidence of the real working relationship.
Step Four: Assess Your Exposure
Work through each freelancer in the period HMRC is checking. For each one, ask three questions:
1. Would HMRC consider them inside IR35?
If the freelancer worked exclusively for you, used your equipment, took direction from your team, and had no real business risk, HMRC will likely argue they should have been on payroll.
2. What tax and NI would have been due?
If the freelancer was inside IR35, your agency should have operated PAYE on their payments. That means income tax at the employee's rate, employee NI, and employer NI at 13.8%. Plus the apprenticeship levy if your total pay bill exceeds £3m.
3. What penalties could apply?
If HMRC decides you were careless (you should have known but did not check properly), penalties start at 15% of the tax due. If they decide the error was deliberate, penalties start at 30%. If you disclosed the error voluntarily before the check started, penalties reduce significantly.
Work out the total potential liability. It can be frightening, but knowing the number is better than guessing.
Step Five: Consider Whether to Use the Contractual Disclosure Facility
If you know there is a significant problem, and particularly if the error was deliberate, you may want to use HMRC's Contractual Disclosure Facility (CDF). This is a formal process for making a full disclosure of tax irregularities. It gives you protection from criminal prosecution in exchange for a full and accurate disclosure of everything.
The CDF is not for minor errors. It is for cases where there is a real risk of a criminal investigation. If you are unsure, speak to a specialist tax advisor before making any disclosure.
Step Six: Prepare Your Response
Your response to HMRC should be structured, clear, and supported by evidence. Do not write a rambling email. Organise your response by freelancer or by issue. For each point, state the facts, provide the evidence, and explain your position.
If you made an error, say so. HMRC is much more lenient with taxpayers who cooperate fully and admit mistakes early. If you disagree with HMRC's interpretation, explain why with reference to the specific working practices, not just the contract terms.
This is where having an experienced accountant matters. Our agency accounting services include handling HMRC compliance checks from start to finish. We know what HMRC expects and how to present your case in the best light.
What Happens After You Respond
HMRC will review your response and either accept it, ask further questions, or issue a closure notice with their conclusions. If they conclude that additional tax is due, they will issue a tax assessment and a penalty notice.
You have the right to appeal any decision. The first stage is a formal review by a different HMRC officer. If that does not resolve the issue, you can take the case to the First-tier Tribunal (Tax Chamber). That is a formal legal process, and you should have professional representation.
Most compliance checks on agency freelancer payments end with either no adjustment or a negotiated settlement. Full-blown tribunal hearings are rare. But they do happen, particularly where the facts are disputed.
How to Reduce the Risk of Future Checks
Once you have dealt with the current check, you want to make sure it does not happen again. Here are the practical steps:
- Use proper contracts. Your freelancer agreements should reflect the actual working relationship, not a template you downloaded. If the freelancer is genuinely self-employed, the contract should give them control over how and when they work, the right to substitute, and the ability to work for other clients.
- Issue Status Determination Statements. If you are a medium or large agency, you are legally required to issue SDS to contractors before they start work. Do it properly and keep records.
- Review freelancer arrangements annually. Working relationships change. A freelancer who started as genuinely self-employed may become more integrated over time. Review each arrangement at least once a year.
- Keep evidence of the real relationship. Save emails, project logs, and timesheets that show how freelancers actually worked. If HMRC checks again in three years, you want to be able to show them what happened.
- Use the CEST tool as a starting point. HMRC's Check Employment Status for Tax tool is not perfect, but it gives you a documented position. If you rely on CEST and the facts match what you entered, HMRC will stand by the result.
For marketing agencies and advertising agencies that rely heavily on freelance creative talent, getting this right is essential. One compliance check can cost thousands in professional fees and management time, even if you win.
When to Get Professional Help
You should involve a qualified accountant as soon as the compliance check letter arrives. Do not try to handle it alone. HMRC officers deal with these cases every day. You do not. The asymmetry of experience is real.
If the check involves significant amounts of tax (say, over £10,000 of potential liability), consider engaging a tax barrister or a specialist tax solicitor as well. The cost is usually worth it if it reduces the final bill.
If your agency tax compliance UK record is clean and this is a random check, you will likely get through it with minimal disruption. If there are real issues to address, professional representation can make the difference between a manageable settlement and a crippling tax bill.
Final Thoughts
An HMRC compliance check is stressful, but it is not the end of the world. Most checks on agency freelancer payments resolve without penalties or with reduced penalties. The key is to respond promptly, provide clear evidence, and be honest about any mistakes.
The agencies that get into serious trouble are the ones that ignore the letters, destroy evidence, or try to mislead HMRC. Do not be that agency.
If you have received a compliance check letter and need help responding, contact us at Agency Founder Finance. We are ICAEW qualified accountants who work exclusively with agency founders. We know how HMRC thinks and how to protect your position.
Get the evidence together, get professional advice, and get the response sent. Then you can get back to running your agency.