IR35 is essential legislation that concerns contractors and those who hire them. It controls the amount of taxes and National Insurance a contractor pays based on how a project is completed. Not staying compliant can cause huge financial consequences, so it’s important to be in the know.
Read on to find out everything you need to know about IR35, from what it is to its determining factors.
What is IR35 in simple terms?
IR35 is legislation that ensures contractors pay the right amount of tax and insurance. This is achieved by preventing workers who are treated as employees from using an intermediary, like a limited company, to evade higher taxes.
The law was introduced when the government suspected contractors were exploiting the system by leaving employment and returning as a limited company. HMRC refers to these as ‘disguised employees’, as they work in a similar way to full-time employees but reap the tax efficiency of a limited company. Limited companies are especially tax efficient as directors can pay themselves a mixture of salary and dividends.
The involved companies may also benefit by not having to provide National Insurance contributions or employment benefits. Although most cases are genuine operations, HMRC introduced the legislation in 2000 to address the loophole and placed the liability on the correct tax to be paid on the contractor, rather than the employer.
IR35 in the public vs private sector
IR35 legislation varies by public and private sector in terms of which party is responsible for assessing status.
Public sector
As of 2017, the hirer became responsible for assessing whether the contractor is inside or outside of IR35.
Private sector
The contractor is responsible for assessing whether they are inside or outside of IR35.
However, upcoming reforms set for April 2021 mean private sector employers will be responsible for determining a contractor’s IR35 status. Continue reading for more on the latest changes.
What does inside and outside IR35 mean?
IR35 can be complex and each case must be considered individually. In short, a contractor will aim to be considered outside of IR35 so that their income deductions will be less.
Inside IR35
Being inside IR35 is not ideal for a contractor. As they are essentially working as an employee would, they will be subject to PAYE (or payroll). This means they will pay the same amount of tax and National Insurance that a full-time employee would, only with lesser benefits to an extent including annual leave entitlement, sick pay, and other company benefits. This extra payment for operating within IR35 is known as ‘deemed payment’.
Outside IR35
Being outside IR35 is good for a contractor. It means they are operating correctly as a limited company. Contractors will pay their own tax and National Insurance contributions, meaning they can determine the most tax-efficient payment. This is usually a mixture of salary (below £12,500 is tax-free) and dividends.
How to tell if you are inside or outside IR35
Assessing your IR35 status depends on whether you’re in the public or private sector, as this determines who is responsible for the assessment. Regardless, the ways to check are the same.
- Use HMRC’s CEST tool: This free tool determines your IR35 status, however HMRC doesn’t legally back the outcome, and it can be very limited. An example of this is Consulting Ltd v HMRC, whereby the tool pointed to a decision that IR35 need not apply, which contradicted the findings of HMRC itself.
- Use an independent tool: Tools like PSC Guard will check your IR35 status and allow you to insure it so if you are challenged, any court costs will be covered by the company.
- Assess your operations: There are a range of reasons why you may be inside IR35. We’ve covered some of these later in the article.
- Get advice: Legal experts can help you navigate IR35 and any changes made to contractors’ employment.
Why does IR35 matter?
IR35 is something contractors and hirers mustn’t ignore. If a contractor is discovered to be inside IR35 when they haven’t claimed as such, they may be liable to pay a penalty to recover unpaid income tax and National Insurance.
HMRC can investigate up to six years ago, meaning being caught out can be extremely financially damaging to a limited company. HMRC have stated that they won’t retrospectively look into limited companies for previous years if their IR35 status were to change, however it’s still important to consider.
If you’re inside IR35, your deemed payment (additional contributions) will need to be calculated for the year. You’ll need to subtract your PAYE salary (plus a 5% expenses allowance if you’re a private sector contractor) and pension contributions. Additional travel and subsistence expenses may also be applicable.
What to do if you’re inside IR35?
If you’re inside IR35, you’ll pay taxes and National Insurance as a full-time employee would. However, you have the right to dispute a determination if you disagree with the outcome.
You can appeal using HMRC’s Alternative Dispute Resolution service for an independent inspector to reassess the case. Alternatively, you can escalate it to court through an IR35 tribunal. It’s worth getting business insurance to cover any fees incurred by challenging decisions. Plus, contractors generally have a high success rate in disputes.
What are the latest changes to IR35?
IR35 legislation has had several changes since its introduction. This includes the 2017 change where the responsibility of checking IR35 status shifted from the contractor to the hirer. Another planned change was set to take place in April 2020 but has since been moved to April 2021 as a result of COVID-19.
From 6th April 2021, the IR35 legislation will be extended to the Private Sector. This means status determination assessments will become the hirer’s responsibility. Organisations will only need to apply the changes to contracts after this date, and small businesses will be excluded as it stands. According to HMRC, a small business meets no more than two of the following: an annual turnover above £10.2 million, a balance sheet total over £5.1 million, or more than 50 employees.
The proposed changes are widely criticised as hirers are often not experienced in IR35, which can lead to incorrect determinations.
IR35 criteria
There’s a range of rules that HMRC applies to determine an inside or outside decision. Essentially, the contract should cover the services provided rather than employment to stay outside of IR35. It aims to outline the differences between being a contractor and a full-time employee.
The key four factors are as follows:
- Supervision, Direction, Control– This refers to the level of control the end client has over your work. For example, set times, involvement in team stand ups, and so on. As a contractor, you should have control over the way you work.
- Substitution– If you’re unable to send another contractor to complete your work, you’re more likely to be inside IR35. This is because sole ownership of a project indicates employee status.
- Mutuality of Obligation (MOO)– If the employer is obligated to offer further work and the contractor has to accept it, you could be inside IR35. In other words, if continuous employment is offered contract after contract, this could indicate permanent employment.
- Risk – This refers to financial risk and whether a contractor can make a profit or a loss. A full-time employee should receive security in finances, whereas a contractor will be liable for any mistakes made. This is why business insurance is strongly recommended.
Other factors include:
- Running a business – This includes having a company website, office space, and employees. To stay outside of IR35, you should complete a project from start to finish and without the control of an employer.
- Equipment – Only using your clients’ equipment indicates a disguised employee.
- Team structure – If a contractor becomes an ingrained team member, this indicates employee status.
- Exclusivity – If you’re working for only one client for a long period, this indicates an employee-employer dynamic as limited companies have the flexibility to work for many, whilst not always the most accurate indicator.
