Simply speaking, IR35 is a piece of tax legislation designed by HMRC to counteract tax avoidance by taxing ‘disguised’ employment at the same rate as similar employment. It is used to assess whether self-employed individuals or freelancers are working genuinely, or if they are working as ‘disguised’ employees, with all the same responsibilities as a full time employee, without having to pay the same tax and national insurance.
What is a ‘disguised’ employee
Any self-employed person, freelancer, or contractor who has the same responsibilities as a current employee of the business, but who is not taxed in the same way and is not making the same contributions to tax and national insurance, and who does not receive the same benefits, is seen as a ‘disguised’ employee.
If you are a self-employed contractor working through a limited company, you can take advantage of tax reductions, but to do so lawfully you need to understand and comply with IR35 rules.
Likewise, companies can take advantage of using contractors and other freelancers as they don’t have to make contributions towards pension or sick pay, and do not have to offer benefits such as holidays and paid leave. This can be hugely beneficial for a company when done in line with the law, but IR35 is in place to ensure that companies are also held to account for monetary contributions towards national insurance and pension where applicable.
Before the introduction of IR35, individuals could set up their own limited companies and work as contractors to the company, taking advantage of limited company benefits. This meant that profits could be distributed as dividends to company shareholders, often family members, without being subject to national insurance payments. Splitting the dividends also meant that taxation could be decreased by lowering the tax band.
IR35 is also referred to in some cases as the ‘intermediaries legislation’ because it applies to individuals who work through an intermediary rather than working directly under an employer. This intermediary is often the individual’s own limited company, especially in the case of self-employed individuals, but can also be in the form of a partnership, another personal service company, or another individual or agency.
IR35 for the public and private sector
As of 6 April 2021 the public sector and all medium to large private sector companies will fall under the same rules, while small private sector companies will still function slightly differently.
The public sector and companies with an annual turnover of no more than £10.2 million, a balance sheet total of no more than £5.1 million, or no more than 50 employees (they must meet at least 2 of these criteria) will be responsible for working out the IR35 status of their contractors. If they fall inside IR35, then the company also has the responsibility to deduct tax and national insurance contributions. They can do this through internal accounting and payroll or hire an umbrella company to handle it. This is especially relevant for agencies who provide workers but do not have the internal capacity to handle payroll and taxation.
For small private sector companies (a company that does not fit at least 2 of the requirements listed above), the contractor is responsible for working out their own IR35 status. Unlike the rules for the public sector, however, the contractor will assume full responsibility for paying taxes and national insurance instead of the responsibility falling to the client.
What does IR stand for in IR35?
IR35 is the abbreviated name for the anti-tax avoidance legislation that was introduced in April 2000. The IR stands for Inland Revenue, and the 35 is the press release issue number.
IR35 is governed by Her Majesty’s Revenue and Customs, which absorbed Inland revenue back in 2005.
Inside and Outside IR35
When referring to your IR35 status, the common terms you will hear are ‘inside’ and ‘outside’ IR35. Simply put, outside IR35 status applies to those who are genuine contractors while inside IR35 applies to those who are employees for tax purposes. These terms indicate your status of being either inside or outside of the scope of IR35 legislation.
There are three main criteria used to evaluate your IR35 status:
- Supervision, direction, and control
- Mutuality of obligation
Other criteria come into play as well. These are less important but are still used to help decide if a person is inside or outside IR35. They include:
- Regularity and method of pay
- Option of alternative work
- Involvement within corporate structure
- Personal financial involvement and risk
- Employee type benefits
- Part and parcel
- Intentions of both parties
- Contract termination agreement
What does inside IR35 mean?
A person operating inside IR35 is someone who is an employee and is subject to pay Pay As You Earn (PAYE) tax.
You will need to pay a ‘deemed payment’ of income tax based on your tax bracket and this payment can be made at the end of the year or gradually throughout the year.
When it comes to paying PAYE, the company payroll and accounting team may make the deductions for you, or an umbrella company hired by your employer may make the necessary arrangements. As long as you are paying income tax appropriately through the client then you are IR35 compliant and don’t need to be concerned. If you work for a small company, you will also most likely be responsible for paying your own taxes and contributions through HMRC rather than it going through your client or employer.
Generally, an individual inside IR35 complies with the following:
- The individual carries out all the work their company is contracted to do personally
- The individual works for their own limited company, but received employment benefits such as paid sick leave
- The individual is paid on a time basis
- The individual is under close supervision or management by their client or someone in their client’s business
- The individual is supplied with the equipment they need to do the work and can work at a premises provided by the client
- The individual works for a single client and the contract is long-term
- Any rejected work is corrected at the client’s cost and does not have bearing on the individual’s pay
- The individual does not have their own business identity
What does outside IR35 mean?
A person operating outside IR35 is someone who operates as a genuine independent business and therefore falls outside of the scope of IR35.
A person outside IR35 pays their own salary, controls their own books, is able to draw income as dividends, and is fully responsible for all taxes through HMRC. Dividends drawn from limited company income are not subject to national insurance contributions.
If you have your own business insurance, market yourself, own and use your own equipment, or work for multiple clients then you are most likely outside IR35.
You should be aware that if you come under investigation by HMRC for breaking IR35, the investigation will look more closely at your actual working in practice than it will at a paper contract. For this reason, it is always best to do regular reviews of your contracts and agreements to make sure you still fall outside IR35. Individuals with a status outside of IR35 are more likely to come under scrutiny than those inside IR35 because HMRC loses more money from false claims of outside IR35 than they do from people wrongly working inside IR35 (although this does not exclude them from investigation and prosecution).
Generally, an individually outside IR35 complies with the following
- The individual maintains the right to delegate or sub-contract work to another person, and that right is exercised in practice
- The individual does not receive employment benefits such a paid sick leave
- The individual is paid on a project basis or at a set price
- The individual sets their own hours and work location and can decide how and when they work.
- The individual supplies all their own equipment and tools and the client is under no obligation to provide a workspace or work equipment
- The individual works for multiple clients at a time, either on individual projects or on short successive projects
- The individual is liable for any rejected work and pays for mistakes themselves. If work is substandard the client may not pay for the service
- The individual is responsible for their own premises, insurance, marketing, and branding
Deciding your IR35 Status
If you are still struggling to decide if you are inside or outside IR35, use the table below to help you. Note that the first three rows are the most important ones in deciding IR35 status and should be considered more carefully than the final three rows.
|Inside IR35||Outside IR35|
|Control||The client or employer controls how, when, and where the services are delivered. They maintain working control over the contractor||The contractor works with greater autonomy and controls how, when, and where services are delivered. Although they may work within an agreed time-frame, they are in control of their own work and conditions.|
|Mutuality of obligation||There is an obligation for the employer to continue providing work to the employee, and an obligation for the employee to continue to accept the work||There is no obligation on either party to continue working with one another, apart from any work that has already been agreed|
|Substitution||The employer cannot or will not be able to use a substitute to provide the necessary services. There is an obligation of personal service||The contractor could provide and pay a substitute to carry out the work if necessary|
|Equipment||The Employer provides all necessary equipment to complete the job||The contractor provides their own equipment|
|Parts and Parcel||The contractor is not viewed or treated any differently than any other company employee.||The contractor is clearly identified as an external resource. There is a clear distinction between company employees and external contractors.|
|Financial Risk||There is no financial risk to the contractor. The quality of the service they deliver does not influence their pay.||The contractor undertakes financial risk and is usually paid either in partially or fully only when the service has been delivered. The contractor is also responsible for insurance and other self-employed business running costs|
You should bear in mind that this can be blurry territory. Some areas may apply to your line of business while others do not, and in some cases there may be a mix of answers. Look at which side of the table the majority of your work lies on to help you ascertain if you are inside or outside IR35.
Generally, a contract with an end client for services usually falls outside the scope of IR35 whereas a contract of service falls inside the scope of IR35. This is because contracts for a provided service can usually be substituted, or performed by another person.
HMRC has also created an online tool to help you check your IR35 status. This CEST (check employment status for tax) tool works alongside the HMRC IR35 helpline to help you check your status. Unfortunately, the tool is not always fully reliable as it doesn’t take into account mutuality of obligation which is a key piece of case law.
As long as you are honest in your answers and very clearly trying to work within all legal requirements, there is often a way to defend yourself to HMRC should it come to that.
What does the IR35 change in 2021 mean?
IR35 itself is not changing, and as long as you were working within the legislation before, there should be no impact on you.
The main thing that is changing is the introduction of something called the ‘off-payroll working’ rules. These rules stipulate that the responsibility of identifying an employee or contractor’s IR35 status now falls to the employer, company, or business, rather than to the individual contractor.
This change was already in place in 2017 for the public sector but will apply to the private sector as of April 2021. The changes will only apply to medium and large companies, so anyone employed by a small company will still need to do a self-assessment to decide if they are inside or outside IR35 and make sure they are complying with all legislatures.