IR35: what it is and what it means for freelancers and contractors

Finance and legal

22 August 2018

If you’re a self-employed contractor or freelancer, you might have heard about IR35 legislation. If you haven’t read about the legislation or are still unsure what IR35 means for you, AXA is here to help explain.  

Designed to help HMRC identify tax avoidance, the self-employment tests and criteria established by IR35 affect everyone who works as a contractor or freelancer.

Here, we reveal what you need to know to ensure you don’t become an accidental tax avoidance target for HMRC when the IR35 legislation changes come into effect in 2019.

What is IR35?

IR35 is an anti-tax-avoidance rule that impacts all contractors and freelancers who don’t meet HMRC’s definition of self-employment. IR35 comes into play when an individual – whether a freelancer or contractor – provides services for an organisation, but rather than being employed and paid directly, the individual invoices the organisation through a company.

This transactional relationship is typically genuine, and there are plenty of sole trader limited companies operating in the UK. However, it’s unfortunately not uncommon for some organisations to pay people in this way so that they can avoid paying employers’ National Insurance contributions or providing employment benefits.

To combat this, IR35 is designed to ensure that contractors working via their limited companies deemed to be doing the same work of an employee pays broadly the same tax. An HMRC inspector will determine this by applying an employment test to each case, which is based on the actual working practices, rather than any contract.

To show that there is no employment relationship, the contractor has to prove certain relationship criteria to determine whether they are 'inside' or 'outside' IR35. These are based on the following:

  1. Control – does the organisation or contractor control the work?
  2. Substitution – can the contractor send someone else in their place?
  3. Mutuality of obligation – is the organisation obliged to provide work, and the contractor to accept it?

If the contractor passes the test, they are 'outside' IR35, and can continue to invoice then pay themselves through their own limited company. If they are deemed 'inside' IR35 and HMRC declares that it’s an employment relationship, then tax and National Insurance will be deducted from their earnings and the liability for any missing tax lies with them.

How did IR35 reform impact the public sector?

Until April 2017, IR35 employment status was declared by the contractor and not the hiring organisation. In 2017, the rules changed for the public sector, and the onus to prove self-employed status became the responsibility of the hirer. It could be viewed as the worst of both worlds for the contractor: if found to be 'inside’ IR35, they will be taxed and pay NI as employees, but still won’t receive employee benefits.

These changes made hiring contractors a riskier business, as the hirer is fined if they incorrectly identify an IR35 contractor as an 'outsider'. In a bid to avoid this, some public bodies, including HMRC, NHS and the MOD, have ceased using any limited company contractors.

Potential future changes to IR35 for the private sector

The government’s stance is that contractors paying less tax than employees is an unfair anomaly, and as such they are currently in consultation about further reforms. As a result, the IR35 reforms already implemented in the public sector are likely to be extended to private sector contracts, either next year or in 2020.

Although there are no details on the table just yet, there are concerns that organisations will be wary about contracting out work, or that contractors will need to work and operate through PAYE umbrella companies. So, with time to prepare, what can Britain’s small businesses do?

How freelancers and contractors prepare for private sector IR35 reform

Although the full ins and outs of the proposed changes won’t be fleshed out until November’s Autumn Budget, there are easy ways you can prepare for IR35 amendments right now:

Take the test

To find out if you are ‘inside’ or ‘outside’ IR35, you should first take the HMRC IR35 test, which will assess your current work practices.

Review your current practices

Audit your current working practices based on the results of the HMRC test. Think about how IR35 changes could affect how you do business – and what you can do to help solve potential problems.

Seek expert advice

Before making any changes to how you conduct business, get advice from legal experts to make sure any changes you make are still compliant with IR35 and other laws and regulations.

Although there are few concrete details showing how IR35 reform will impact the private sector in 2019, it could benefit your business greatly if you read up on how the changes have already affected the public sector. By learning lessons from public sector IR35 reform it could help your business could stay one step ahead and give you time to adapt the strategy as to how you work with freelancers and contractors to meet organisational goals.  

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