One of the biggest issues facing contractors is the IR35 legislation. Considered by many to be a thorn in the side of limited company contractors, these tax rules are notoriously complex, often misunderstood and even misapplied.
But the fact of the matter is that if you work as a contractor, it’s important that you have at least a base level understanding of the legislation, such as the financial implications of working inside or outside IR35.
So in this article, we’ll run through everything you need to know about IR35.
What is IR35?
The official term for IR35 is the Intermediaries Legislation. And in fact, IR35 was just the title of the press release issued by HMRC in 1999 ahead of its introduction in 2000. It read, ‘Inland Revenue 35’, hence the term IR35.
IR35 is a tax legislation that aims to prevent disguised employment. By this we mean that it’s in force to identify if a contractor is genuinely self-employed or is working as a disguised employee and therefore avoiding tax.
In theory, its existence makes sense. But in practice, the arrival of IR35 over two decades ago brought with it a number of issues - the biggest of which is how you tell the difference between a genuine contractor and a disguised employee.
What does outside IR35 mean?
If you work outside IR35 your contract and working practices are structured in a way that reflects a genuine business to business relationship. In other words, you are truly self-employed and therefore can continue to pay yourself via your limited company - sometimes referred to as a personal service company (PSC) - with a certain level of tax efficiency.
What about inside IR35?
In contrast, if you deliver your services to a client in a manner that resembles employment, you should be operating inside IR35. Due to this, HMRC is of the view that you should be taxed like an employee. You’ll therefore pay Income Tax and National Insurance Contributions (NICs), as an employee.
Both of the above terms are known as ‘IR35 status’. We’ll now explain some of the factors that are taken into account when determining IR35 status.
There are three key status tests, which are:
Control
This relates to the level of control that exists in the working relationship. If, for example, you find that your client has a high level of control over how you deliver your services (such as your working hours, where you’re expected to work from and the autonomy you have over your work), you may find that your assignment points towards an employment relationship and therefore belongs inside IR35.
Look at it like this - while employees must abide by the processes of their employer, often report to managers, work from an office and typically have set working hours, in theory, a genuine contractor should have some freedom over how they carry out their work.
Mutuality of Obligation (MOO)
MOO focuses on the obligation a client has to provide paid work to you and the obligation you have to accept this work. In an ideal world, in an outside IR35 contract MOO shouldn’t exist. Contractors, as business owners, should be able to turn down work from clients as and when they want. Employees, on the other hand, have an obligation to work for their employer, which is why MOO is present in employment contracts.
Personal Service
This is centred on whether you provide your services as a business or as you, Joe Bloggs. Again, to strengthen your case for operating outside IR35, it’s important not to deliver a personal service. This is something that employees do and it puts you at risk of your contract being classed as inside IR35.
Many contractors opt to include the right of substitution in their contract (and exercise this right), given it begins to paint a picture of a business to business relationship. For example, an employee couldn’t send in someone else - even if they were qualified - to do their work. But a true contractor should be able to.
There are plenty of other aspects to take into account when assessing IR35 status, including:
Part and parcel - is the contractor part and parcel of their client’s organisation, like an employee? Or is there a clear and distinct difference between how they are treated?
Financial risk - will the contractor rectify mistakes made when delivering their services in their own time, like a business carrying out work would? Or does the financial risk lie with the employer, as it does when an employee makes an error?
Business in your own account - is the contractor in business on their own account? Do they hold insurance? Have a website? Work with multiple clients simultaneously? Or is the limited company they work through simply a vehicle for avoiding tax?
When it comes to determining IR35 status, the words ‘picture painting’ are often used. In other words, all factors should be considered, which will then begin to paint a picture of either self-employment or employment.
Who decides IR35 status?
When IR35 was enforced in 2000, contractors were responsible for determining their own status. However, the government has long held the opinion that contractors have been abusing the rules (although there’s no real proof of this) and so introduced IR35 reform, first in the public sector in April 2017 before rolling out similar changes in the private sector in April 2021.
What is IR35 reform?
Following IR35 reform, it’s now nearly always up to the end client to assess the IR35 status of the contractors they engage.
In the public sector, all organisations are tasked with this, while in the private sector, medium and large businesses must administer the rules. Businesses that qualify as small are exempt from IR35 reform, which means that contractors engaged by them are still responsible for determining their own status.
It’s not just the responsibility of assessment that has shifted from the contractor, but also the risk, also known as the liability. This has transferred from the contractor to the end client, but HMRC will look to recoup the tax liability from the fee payer when the end client can demonstrate they took reasonable care in making the decision. For this reason, compliance throughout the supply chain, including any recruitment agencies, is required.
So what can contractors do about IR35?
Needless to say, given the financial difference between working inside or outside IR35, contractors are advised to make sure they are operating under the correct status - even if in the majority of cases it will be their client who determines this position.
An independent IR35 status review is widely considered as the best way to go about this. An IR35 expert will thoroughly review your contract (and working practices if asked), before feeding back with their opinion.
Umbrella working is also an increasingly popular option, should your client have decided that - due to IR35 reform - they would prefer not to engage with contractors. IR35 isn’t applicable to umbrella workers because you are an employee of the umbrella. This means you will be paid via PAYE but, unlike working inside IR35 via your limited company, you will be granted employment rights in exchange for paying employment tax.