What is IR35? A guide for the self-employed

IR35 is designed to assess whether a contractor is a genuine contractor rather than a ‘disguised’ employee, for the purposes of paying tax.

Contractors who work through their limited company enjoy a level of tax efficiency. While they don’t get employee benefits (like holiday and sick pay), they have flexibility and control over their work.

Enter HMRC and IR35

HMRC introduced IR35 (or the ‘off-payroll working rules’) in 2000 to tackle what they call ‘disguised’ employment.

Some contractors (and their hirers) might try to take advantage of the tax efficiency of working through a limited company, when in practice the contractor is essentially working as an employee.

The benefit for employers hiring workers in this way is that they don’t have to pay employers’ National Insurance contributions or give contractors employee benefits. The benefit for contractors is tax efficiency.

So, IR35 assesses whether contractors are for all intents and purposes employees when they take on work for clients. If you’re ‘inside IR35,’ HMRC sees you as an employee and you face an income tax and National Insurance burden, just as employees do. You don’t face this if you’re ‘outside IR35.’

Many find the legislation complicated to understand. Even HMRC seem to struggle – their record on successfully fighting IR35 cases at tribunal is patchy. This lack of clarity, along with ambiguity over employment status guidelines (including the available employment rights if contractors are found within IR35), has proven controversial since the law’s introduction.

IR35 rules for limited companies

When does IR35 apply?

HMRC say that when determining whether IR35 applies to a contract or engagement, “you must work out the employment status of the person providing their services.”

HMRC go on to say that the off-payroll rules apply if the contractor “would be an employee if there was no intermediary”. The intermediary in most cases is the contractor’s limited company (often called a personal service company).

Have a look at our checklist below to see which key tests you can use to establish employment status.

HMRC also have a tool you can use to check whether IR35 applies to a contract (CEST, or the ‘check employment status for tax’ tool), plus an IR35 helpline.

There’s more to IR35 status

In reality IR35 status hinges on IR35 case law and employment legislation, itself reliant on decades worth of employment tests heard in the UK courts.

Another problem is that HMRC’s CEST tool may not be entirely accurate, as it doesn’t take a key piece of case law (mutuality of obligation, or MOO) into account.

IR35’s nuances mean that contractors can’t be expected to know the law inside out. You should only use this article as a guide. If you’re unsure about anything please seek advice from an IR35 expert – there are many professionals out there who offer contract review services.

Public sector and private sector rules

There are currently different rules for public sector and private sector contracts.

  • for public sector contracts – the hirer is responsible for working out whether the contractor falls inside or outside of IR35. If they fall inside, the hirer, agency or other third party who pays the contractor then needs to deduct tax and NICs and report them to HMRC

  • for private sector contracts – the contractor is responsible for working out whether they fall inside or outside of IR35. If they’re inside, they need to pay the tax and NICs due

Private sector IR35 reform is set for April 2020, when the public sector rules will be applied to the private sector. This means private sector employers hiring contractors will be responsible for determining their IR35 status. Businesses and contractors should start preparing for this change as soon as possible.

IR35 checklist: am I compliant?

If you’re a contractor working out whether IR35 applies to a contract, there are a few principles to consider as part of a checklist.

In general, IR35 won’t apply if the contract is for services rather than employment. To untangle that, you should see whether the contract specifically mentions these principles:

  • supervision, direction, control – this relates to how much say your client has over how you complete your work. For example, if you have to work at certain times, this implies employment
  • substitution – could you bring someone else in to complete the contract, or do you need to do the work yourself? If you can’t send someone else, you’re likely to be within IR35
  • mutuality of obligation (MOO) – is there an obligation on the employer’s end to offer work, and do you have to accept it? This is called mutuality of obligation, and if it exists, the contract will fall within IR35

Supervision, direction, control

For a contract to fall outside of IR35, contractors should have freedom over how they complete their work. A contract that specifies things like the time you can start and finish work, or the days you’re required to work, is one that points towards employment.

Other elements of an employment contract that HMRC look out for include a client overseeing your work excessively, and giving guidance on how to complete it.

Plus, if you’re not only providing your services for the agreed job but also working on different tasks as your client sees fit, the contract is likely to be within IR35.

Substitution

Does your client only want you? For a contract to fall outside of IR35, you should be able to send a substitute to complete the work instead.

This means the contract should state that someone else can provide their services to complete the work. The clause has to be genuine – you should know which skilled contractors you would ask, plus the contract can’t be so restrictive that you essentially need to do the work yourself.

Mutuality of obligation (MOO)

This is an important clause to include in a contract, as it’s a key test when determining self-employed status.

If the client is obliged to offer work (and pay you) and you’re obliged to take it, this demonstrates a contract of employment. In practice, a self-employed contract means working on a project-by-project basis. Once you’ve completed a project, you’re under no obligation to work on further tasks (and the client is under no obligation to offer them).

You should also consider whether you can work for other clients simultaneously. If a client and contract prohibits that, it points towards you being an employee rather than self-employed.

Other factors on your IR35 checklist

There’s more criteria to consider when determining your IR35 status:

  • equipment – HMRC often try to argue that if equipment is provided by the client, and you don’t use your own, you’re a disguised employee

  • financial risk – self-employed contractors usually take a degree of financial risk, like any business would. Are you responsible for errors made during the contract, and would you need to rectify them in your own time? There’s usually a requirement to have professional indemnity insurance

  • the way you’re paid – self-employed people are paid on a project basis, which might mean when the work is completed or at particular project milestones

  • ‘part and parcel’ of the organisation – if contractors become so ingrained that they become part of a company’s structure, with people reporting to them for example, this points to employment rather than self-employment

  • exclusivity – do you work for other clients? Typically the self-employed can work for multiple clients at once

  • intentions of the parties – the contract should make sure the relationship between contractor and client is one of supplier and customer, but this should be genuine. If HMRC found the actual intended relationship is more like an employee and employer, they’ll ignore the contract

  • business ‘on your own account’ – essentially this determines whether you’re actually running your business as a business. If you have things like a business website, a dedicated office space, and even employees, you could be seen as operating a business and not offering your services in the same way as an employee

Make sure you clarify your relationship with the hirer before you start the contract by considering all of these principles. Again, before you start working, you should seek expert IR35 advice.

Have you thought about business insurance?

Contractors should think about a comprehensive business insurance policy, including:

  • business legal protection insurance: this can cover the legal expenses for things like employment tribunals and HMRC tax investigations – including a dispute about your compliance with IR35 regulations

  • professional indemnity insurance: a key cover for contractors and those who give professional services to clients. It can protect you if you make a mistake in your work that causes a financial or professional loss for your client

  • public liability insurance: this can protect you if a member of the public is injured or suffers a loss because of your business and makes a claim

  • business contents insurance: this can cover the equipment your business relies on every day, like PCs and laptops

Do you find the IR35 rules too complex? Let us know about your experiences with IR35 in the comments below.

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