Minutes to read 5
The term IR35 can understandably invoke feelings of anxiety and frustration amongst contractors, freelancers and the self-employed. The legislation can be confusing and the interpretation of the rules can be subjective to an extent which leads to grey areas and uncertainty. Therefore, it’s not always easy to ensure compliance, but it’s very important that the rules are followed.
Understanding the meaning of IR35 and correctly classifying your contracts has significant implications on how you pay your tax, how much tax you pay, the employment benefits that you receive and much more.
IR35 isn’t a new piece of legislation and many long-term self-employed have been contending with it for nearly a quarter of a century, but it can be challenging both for seasoned contractors and those new to self-employment.
IR35 was first broached in 1999 by the Inland Revenue (now HMRC) and it became legislation in April 2000. A lot has changed since then and IR35 has undergone numerous revisions in the subsequent years to address loopholes, issues, and frustrations of those impacted by it.
In this post we’ll examine what IR35 is and how the IR35 status determination impacts the self-employed.
What is IR35?
IR35 is a piece of tax legislation that’s also referred to as ‘intermediary legislation’ or the ‘off-payroll working rules’. It’s designed to prevent tax avoidance in situations where employers engage genuine employees on a contract basis, referred to as disguised employees.
When a genuine employee is engaged on a contractor basis they can leverage tax efficiencies to lower their tax liability which HMRC estimates loses them £1.2bn in tax revenue annually. Employers also wouldn’t have to provide various employment benefits or pay Employer’s National Insurance Contributions or pension contributions.
How IR35 Works
The IR35 rules are applied to the working practices rather than to the contractors themselves. The nature of the working practices – and as such the contract in place – is assessed to provide an IR35 status determination which will either be Outside IR35 or Inside IR35. The main factors assessed are:
The Level of Control
If the contractor has control over their hours and the location they work from and control over how the service is delivered, this is an indicator that the engagement will be outside IR35. If the client controls the working hours and location and has autonomy over how the service is delivered, as you’d expect in a normal employer/employee relationship, this is an indicator that this is an inside IR35 working arrangement.
The Right of Substitution
If a contractor was unable to work, through illness for example, and didn’t have the right to provide a substitute to work in their place, this would indicate they’re an employee and would sit inside IR35. If they could provide a substitute to work in their place, such as an employee of their business, this indicates they would be considered outside IR35.
Mutuality of Obligation
Contracts have set start and end dates and there should be no expectation of any further work once a contract is completed. If there is, this indicates the engagement is inside IR35. If there’s no expectation of further work after completion, this is a pointer to the engagement falling outside IR35.
What It Means to Be Outside IR35
Being outside IR35 is the perfect scenario for limited company contractors and freelancers. When your contracts are outside IR35, you are genuinely self-employed, working for and being paid by your own limited company. A gross amount will be paid to your business by your clients for your services and you can then structure your income how you best see fit.
You have responsibility for your tax obligations and you can leverage tax-efficiencies, such as paying yourself a smaller salary at a tax-efficient level and supplementing your income through dividends, to reduce your overall tax liability and increase your take home pay whilst remaining compliant.
You also have full autonomy over your working arrangements including when you work, where you work and how you do it.
What It Means to Be Inside IR35
If a contract is inside IR35, HMRC considers you to be an employee for tax purposes. This means that your income tax and National Insurance payments will be deducted at source through Pay As You Earn (PAYE). The result of this is that you will pay more tax as there’s no scope to implement tax-optimisation strategies.
Who is Responsible for Determining IR35 Status?
The responsibility of determining IR35 status is dependent on whether a contract is with the public sector, or on the size of the business that’s engaging the contractor/employee if it’s a private sector contract.
Small Businesses in the Private Sector
When the contract is with a small business in the private sector, the contractor has responsibility for determining IR35 status. A small business is any business that meets 2 or more of these criteria:
- Annual turnover below £10.2m
- 50 employees or less
- Balance sheet total below £5.1m
Medium and Large Businesses in the Private Sector
For contracts with medium and large businesses in the private sector, the business itself has the responsibility of determining IR35 status. Unless the business/end client is based outside the UK, in which case the responsibility for determining the IR35 status can be more complex.
The Public Sector
If the contract is with the public sector the responsibility of determining the IR35 contract status sits with the public authority rather than the contractor.
Status Determination Statements
When a contract is with the public sector or a medium or large private sector business, the end client must produce an IR35 status determination statement (SDS). This formally confirms whether the contract is inside or outside IR35 and the reasons why that decision has been reached.
Tips To Help Ensure IR35 Compliance
It’s important to ensure ongoing compliance with IR35 regulations so you pay the right amount of tax and don’t incur any penalties from HMRC.
Use The HMRC CEST Tool
HMRC’s Check Employment Status for Tax (CEST) digital assessment tool can be used to give an indication of whether a contract falls inside or outside IR35. Multiple-choice questions are used to assess the level of control, the right of substitution and mutuality of obligation in the working relationship in a contract to give a non-binding assessment of the IR35 status from HMRC.
Regularly Review Your Contracts
There are various benefits of regularly reviewing your contracts from an IR35 perspective. Regular reviews mean you have certainty that your IR35 status is correctly determined and peace of mind knowing exactly where you stand, that you’re compliant with your tax obligations and you won’t be incurring any fines or penalties from HMRC.
Stay In The Loop
IR35 legislation is fluid and there have been many revisions to the rules since it was introduced, and there will be more in the future. It’s important to keep abreast of any legislative changes so that you remain compliant with the latest regulations and pay the correct amount of tax.
Gorilla Accounting and IR35
Accurately determining the IR35 status of a contract isn’t always easy and if you’re unsure, it’s sensible to engage a professional to ensure that your status determination is correct so you are compliant.
This is why Gorilla Accounting has partnered with industry experts Qdos to provide a free IR35 assessment.
A Qdos IR35 contract assessment provides an expert overall opinion of your IR35 status based on the written terms and conditions of your contract between your limited company and your agency or end client. Qdos will point out clauses where HMRC may find issues and provide suggestions for positive changes and improvements which could be made where relevant so you can start your contract on the right footing.
Trust Qdos to guide you through the complexities of IR35 with precision and clarity. Get in touch with Qdos here for your free IR35 assessment. The usual price is £49 plus VAT.
If you’re outside IR35 and would like to learn more about how our limited company accounting service can help you, including how to optimise your tax-efficiency, speak to an accountant today on 0330 024 0406 or request a callback at your convenience here.
