What is IR35? A guide for the self-employed

What is IR35? Everything contractors need to know

IR35 is another name for the off-payroll working rules. The term ‘IR35’ refers to the press release that originally announced the legislation in 1999.

Self-employed IR35 rules are designed to work out whether a contractor is genuinely self-employed rather than a ‘disguised’ employee for tax purposes.

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

Some contractors try to take advantage of this tax efficiency by appearing self-employed on the surface. But in reality, they’d be an employee if they weren’t providing their services through their limited company. The off-payroll working rules are designed to tackle this – but they aren’t without their problems.

What is a disguised employee?

When a contractor is a ‘disguised’ employee, they’re taking advantage of the tax efficiency of working through a limited company. But in the eyes of HMRC, they should be classed as an employee.

Consider the example of an employee who quits their job on a Friday. They then start back at the company in the same position on the Monday, but as a contractor working through a limited company. Has the arrangement changed in any material way?

‘Disguised’ arrangements benefit employers too. It means they don’t have to pay employers’ National Insurance contributions or give any employee benefits to contractors.

Inside and outside IR35 – what’s the difference?

Self-employed IR35 rules tackle those arrangements by testing the contract itself to work out whether it’s ‘inside IR35’ or ‘outside IR35’.

If your contract is inside IR35, it points towards employment. HMRC sees you as an employee and you face an income tax and National Insurance burden – just as employees do.

If your contract is outside IR35, it points towards genuine self-employment. You can enjoy the tax efficiency that self-employment brings, as well as all the associated risks.

Being inside IR35 can have a massive impact on your earnings. Recent data from itcontracting shows it can reduce your annual take-home pay by thousands of pounds due to extra income tax and national insurance deductions.

IR35’s nuances mean that contractors can’t be expected to know the law inside out. Please only use this article as a guide – if you’re unsure about anything, seek professional advice.

When does IR35 apply?

HMRC says you must look at the employment status of the person providing the services to see if IR35 applies. The off-payroll rules apply if the contractor would be an employee if there was no intermediary.

The intermediary in many cases is the contractor’s limited company, which is often called a personal service company.

If you work on multiple contracts, it’s possible that some fall within off-payroll working rules and some don’t. This is because these rules are based on each specific contract.

Around 88% of UK contractors are currently determined to be outside IR35, while 12% fall inside the rules (The Association of Independent Professionals and the Self-Employed).

What is an intermediary?

People also call IR35 the ‘intermediaries legislation’. This is because it applies to workers who provide their services through an intermediary, rather than working directly as an employee.

The intermediary will often be the contractor’s own limited company, or personal service company. This is a limited company where the sole director owns most or all of the shares.

But the government website says there can be other intermediaries, such as a partnership, another personal service company, or an individual.

A contractor can provide their services directly to clients through their intermediary. Alternatively, they might work through an agency or umbrella company.

IR35 rules: how to comply?

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 inside 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 an element of it exists, the contract may fall inside IR35

The contract has to reflect your actual working practices – essentially, the clauses need to be genuine.

Supervision, direction, control

For a contract to fall outside IR35, you should have freedom over how you complete your work.

A contract that specifies things like the time you can start and finish work, or the days you’re required to work, points towards employment. It might also point towards employment if a client oversees your work excessively and gives guidance on how to complete it.

If you’re working on different tasks as your client sees fit rather than just the agreed job, the contract is likely to be inside IR35.

Substitution

For a contract to fall outside IR35, you should be able to send a substitute to complete the work instead.

Does your client only want you, or services more broadly? An outside IR35 contract might state that someone else can step in to complete the work.

This clause has to be genuine, meaning you should know exactly which skilled contractors you’d ask to fill in. 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 in a contract, as it’s a key test when working out your self-employed status. If the client is obliged to offer work and you’re obliged to take it, this demonstrates a contract of employment.

In practice, a self-employed contract involves 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 at the same time. If that’s prohibited, it points towards employment.

Other IR35 criteria: checking your contract in full

There’s more criteria to consider when working out your IR35 status.

HMRC often tries to argue that if the client provides your equipment, you’re a disguised employee. Self-employed contractors also usually take a degree of financial risk. For example, if you make an error, you’d need to fix it in your own time – which is why there’s usually a requirement to have professional indemnity insurance.

Self-employed people are paid on a project basis, which might mean getting paid when the work is completed or at particular milestones. If you become so ingrained that you become part of a company’s structure, this points to employment.

Typically, the self-employed can work for multiple clients at once. Your contract should make sure the relationship between you and the client is one of supplier and customer, but this must be genuine. If HMRC finds the actual relationship is more like an employee and employer, they’ll ignore the contract.

Finally, you need to show you’re running your business as a business. If you have a business website, dedicated office space, and employees, you’re seen as operating a business rather than acting as an employee. Make sure you clarify your relationship with the hirer before you start the contract.

HMRC also has a tool to check employment status for tax called CEST that you can use to see whether IR35 applies to a contract. They also offer an IR35 helpline.

In reality, your IR35 status hinges on IR35 case law and employment legislation. This relies on decades worth of employment tests heard in UK courts.

Another problem is that CEST may not be entirely accurate, as it doesn’t take mutuality of obligation into account.

If you’re uncertain about the IR35 status of a contract you’re working on you should consult a professional. 

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• What is an umbrella company?
• Certificate of Incorporation: registering with Companies House
• Small business tax changes: new thresholds, rates, and allowances