A guide for the self-employed
Being inside IR35 means your contract falls in the off-payroll working rules and HMRC sees you as an employee for tax purposes.
What is IR35?
IR35 rules are 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 usually get employee benefits (like holiday and sick pay), they have flexibility and control over their work.
HMRC and IR35
HMRC introduced IR35 (or the ‘off-payroll working rules’) in 2000 to tackle what it calls ‘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 a contractor who’s ‘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 seems to struggle – its 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 inside IR35), has proven controversial since the law’s introduction.
IR35 rules for limited companies
When does IR35 apply?
HMRC says 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 goes on to say that 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 (often called a personal service company).
Intermediary meaning: what is an intermediary?
IR35 is also known as the ‘intermediaries’ legislation’ because it applies to workers who provide their services through an intermediary, rather than working as an employee.
As mentioned, the intermediary will often be the contractor’s own limited company, or personal service company.
A personal service company is a limited company where the sole director, the contractor, owns most or all of the shares. The contractor then delivers services to clients.
But gov.uk says that there can be other intermediaries:
- a partnership,
- another personal service company, and
- an individual.
A contractor can provide their services directly to clients through their intermediary, or they might work with an agency.
Updated 5 February 2021 to mention that private sector changes apply from April 2021, adding what counts as a small company and details on the client-led disagreement process
What does inside IR35 mean?
HMRC introduced the off-payroll working rules (IR35) in 2000 to make sure that contractors who would be employees if there was no intermediary pay broadly the same tax as employees.
That means that if a contract is inside IR35, you have to pay income tax and National Insurance Contributions just like employees do.
If a contract is outside IR35 it means you’re operating as a proper business. HMRC sees you as self-employed and you’re able to pay yourself in a tax-efficient way.
Who determines whether I’m inside IR35?
The rules are different depending on whether your client is in the public or private sector.
Public sector contractors – your end client is responsible for determining your IR35 status. That means they’ll use HMRC’s check employment status for tax tool (CEST), or an independent service, to work it out
Private sector contractors – you’re responsible for determining your IR35 status. But this is set to change from April 2021, when medium-sized and larger clients will be responsible for determining your IR35 status. The end-client, or the agency or third party who pays you, will deduct your tax and National Insurance contributions (smaller clients are exempt from the change)
A small end-client will fall under two or more of these requirements:
- turnover of no more than £10.2 million
- balance sheet total of no more than £5.1 million
- no more than 50 employees
If your end-client is working out your status from April 2021, it needs to give you and the relevant parties (like recruiters) a Status Determination Statement (SDS), which explains whether IR35 applies to the contract.
End-clients need to show they’ve taken ‘reasonable care’ when working out your employment status – otherwise they could be responsible for getting things wrong.
It also needs to have a disagreement process you can use, to object to the decision. Your client needs to respond to your objection within 45 days, saying why it came to the decision, or updating its reasoning based on your objections. If it’s updating its decision, the client will need to change the SDS and give it to the relevant parties.
How do I know whether I’m inside IR35?
One way to work out whether a contract falls inside IR35 or outside IR35 is by using HMRC’s check employment status for tax tool.
- To use the tool HMRC says you need:
- details of the contract,
- the worker’s responsibilities,
- who decides what work needs doing?
- who decides when, where and how the work is done?
- how the worker will be paid?
- if the engagement includes any corporate benefits or reimbursement for expenses.
What about Mutuality of Obligation (MOO)?
HMRC’s tool assumes there’s a contract in place, but it doesn’t take Mutuality of Obligation (MOO) into account. Mutuality of Obligation refers to the employer’s obligation to provide and pay for work and the contractor’s obligation to complete the work.
The fact that CEST doesn’t take a key piece of case law into account has been controversial.
MOO has been the deciding factor in a number of IR35 tribunals, which is just one reason it’s important to get independent advice too. There are lots of accountants who offer independent IR35 contract review services.
Does CEST give accurate results?
For its part, HMRC says CEST is accurate and it “will stand by the results, provided the information input is accurate and it is used in accordance with our guidance.”
HMRC can open an investigation into your IR35 status if it thinks an outside IR35 determination is wrong, so it’s important to keep accurate financial records and tax return information.
Make sure you have IR35 compliance in mind and actively discuss your status with your clients, who should also be preparing for the April 2021 changes if the status decision will now fall on them.
Other factors on your IR35 checklist
There’s more criteria to consider when working out your IR35 status:
- equipment – HMRC often tries 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, it’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
Inside IR35 vs outside IR35 comparison
Your IR35 status has different implications for the tax you pay.
When you’re inside IR35 you:
- are classed as an employee for tax purposes
- need to pay income tax and National Insurance Contributions
- pay this tax by making a ‘deemed payment’ at the end of the tax year
Working out your deemed payment can be complex, so it’s best to speak to your accountant to make sure you get it right.
But if you’re a public sector contractor, your fee payer will work out and pay your tax and NICs on your behalf (this applies to those in the private sector from April 2021 too).
Even though HMRC sees you as an employee for tax purposes when you’re inside IR35, you might not be entitled to employee benefits like holiday pay and sick pay.
When you’re outside IR35 you:
- are self-employed and operate as a proper business
- are responsible for your business’s taxes
- can pay yourself in a tax-efficient way
If you’re outside IR35 you’ll be paid your fee and will be responsible for managing your business’s taxes as normal.
Should I avoid inside IR35 contracts?
You can continue to run your limited company even when a contract is inside IR35. As mentioned, it means you need to make a ‘deemed payment’ to HMRC for the contracts caught inside the rules.
So it’s perfectly possible for professional contractors to have a mix of contracts both inside and outside of IR35 – but it means you’ll need to be organised and ask for professional advice, if you need it.
Do you find the IR35 rules too complex?
The off-payroll working rules are complex. Please only use this article as a guide and if you’re unsure about whether a contract falls inside IR35 or outside IR35, get professional advice.