What is IR35? What your business needs to know

Finance and legal

26 June 2019

  

If you’re a freelancer or self-employed contractor, it’s likely that you’ve heard of, and are confused by, IR35 rules. You’re not alone.

IR35, also known as intermediaries legislation, is infamous for being head-scratchingly complicated. And with further changes set to come into effect in 2020, the clock is ticking on wrapping your head around IR35’s complexities and how it could impact your business.

To help make things a little simpler, AXA examines the ins and outs of IR35, the impact it could have on contractors, freelancer and limited companies, and how to keep tabs on your tax to ensure you stay on HMRC’s good side.

 

What is IR35?

First introduced in 2000, IR35 is designed to reduce tax avoidance by contractors who HMRC believe to be “disguised employees” – people who work in a similar way to full-time employees but bill for their services via their limited companies to make their business as tax efficient as possible.

The majority of these transactional relationships are genuine, and there are plenty of sole trader limited companies operating in the UK. However, it’s 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 rules are designed to ensure that contractors working via their limited companies, deemed to be doing the same work of an employee, pay 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.

 

IR35 rules

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. As a rule of thumb, IR35 won’t apply if the contract is for the services you provide instead of employment. It’s a good idea to keep the following three things in mind when deciding if your business falls inside or outside of IR35:

  1. Mutuality of obligation

    Working as a self-employed contractor means you can work in a project-by-project basis without any obligation to continue working for that client once the contract comes to an end. Equally, clients are under no obligation to continue offering you contracts once the project you’re working on is complete. If a client is obliged to offer you paid work and you’re obliged to take it, this is an example of a contract of employment, meaning you fall within IR35. Also, if a contract states that you can’t take on other clients while working for them, this also places you within IR35.  

  2. Substitution

    If a contract states that the client wants you, and only you, to see a job through from start to finish, then this working relationship will fall within IR35 rules. For a contract to fall outside of IR35 it should highlight that the substitute workers you put forward can complete the contract work on your behalf instead.

  3. Supervision, direction, control

    Contractors must have control over how they complete their work for a contract to fall outside of IR35. If a contract sets working patterns and the client provides excessive input over how work is completed, then it’s likely that this will fall under employment rather than contract work. Keep in mind that if you’re also completing tasks for a client in addition to the contract services you’re already providing, the contract is likely to fall within IR35 too.

If the contractor passes the test, they are 'outside' of IR35 rules, 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.

 

IR35 in the public sector

Originally, IR35 employment status was declared by the contractor and not the hiring organisation. But in 2017, the rules changed significantly for the public sector, with the onus to prove self-employed status shifting from the contractors themselves to 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.

 

IR35 in the private sector

The Government argues that contractors paying less tax than employees is unfair, and as such they are currently in consultation about further IR35 changes. As a result, the IR35 reforms already implemented in the public sector are set to be extended to private sector contracts in 2020.

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?

Private sector IR35 reform is set for April 2020, when the public sector rules will be applied to the private sector. This means private sector employers hiring contractors will be responsible for determining their IR35 status. Businesses and contractors should start preparing for this change as soon as possible.

 

IR35 checklist: test your employment status

Trying figure out how to avoid IR35 or if it applies to contracts you’re working on? Below are some of the factors that HMRC will take into consideration when running an IR35 test, so it’s a good idea to ensure your relationship with your hirer is crystal clear before you begin work.

How you’re paid

To stay outside of IR35, self-employed contract workers tend to be paid on a project-by-project basis, which is usually when work reaches a specific milestone or comes to an end.

Running a business of your own accord

Having a website, dedicated office space and employees all goes in your favour of showing that you’re running your business of your own accord. This reinforces that you’re operating as a self-employed contractor and not offering the services you provide as an employee.

Contractors must have control over how they complete their work for a contract to fall outside of IR35. If a contract sets working patterns and the client provides excessive input over how work is completed, then it’s likely that this will fall under employment rather than contract work. Keep in mind that if you’re also completing tasks for a client in addition to the contract services you’re already providing, the contract is likely to fall within IR35 too.

The equipment you use

If a client provides you with equipment to complete a contract, and you don’t use your own, this could result in HMRC viewing you as a disguised employee. Whenever you’re at the pre-agreement stages of a contract, always make it clear that you’ll be using your own equipment while working to remain outside of IR35, otherwise it could make working out your employment status more difficult.

Contractor remains separate from client business

If a contractor becomes an integral part of a business’s structure, such as having managing employees who report into them, this indicates an employee status as opposed to self-employment.

Exclusivity

One of the major perks of being a self-employed contractor is that you can work for more than one client at once. However, if you’re deemed to be working exclusively for one client only over a prolonged period of time, HMRC could view this as an employee-employer relationship, meaning you fall within IR35.

Financial risk

Self-employed contractors are likelier to experience a higher level of financial risk than an employee would as they have to invest their money into the everyday running of their business. If a client deems work faulty or substandard, putting things to right is a simple way for contractors to demonstrate their exposure to financial risk and a strong indication that they’re in business of their own account.

 

How to calculate IR35 payment

If it’s deemed that IR35 does apply to your contract, you’ll be responsible for paying the outstanding extra income tax and National Insurance contributions. In fact, HMRC can go back at least six years to determine whether or not IR35 applies to any previous work you’ve carried out and can request you to pay any necessary additional penalties and interest.

You’ll need to calculate the deemed payment on your limited company income for the year. This means that you deduct your Pay As You Earn (PAYE) salary, (a 5% expenses allowance if you’re a private sector contractor) and any pension contributions. Certain allowable expenses, such as travel and subsistence, can also be deducted from your turnover too.

Once all of these costs are calculated, you’ll be left with the deemed payment. Whatever’s left over must be treated like a salary from an employer, meaning you’ll also need to calculate the additional tax due too.

 

How to prepare for IR35

It might be tricky to determine your employment status, but thankfully there are easy ways you can make sure you’re adhering to IR35 rules accordingly when taking on a contract:

Take the IR35 test

To find out if you are ‘inside’ or ‘outside’ IR35, take the HMRC IR35 test to 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 it’s yet to be seen just how it will impact the private sector come 2020, reading up on IR35 rules and how it’s already affected the public sector could yield big benefits for your business. Not only could being clued up on IR35 rules help keep your business as tax efficient as possible, it could aid you greatly in establishing a strategy to work as effectively as possible – whether you’re a contractor yourself or rely on their services.

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