HMRC and IR35
Disclaimer - Please note that this article does not in anyway constitute tax advice by GV Accounting Services or any of its representatives. The article is purely for information purposes only. Please kindly contact us if you require tax advice on the subject of 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
- an individual
A contractor can provide their services directly to clients through their intermediary, or they might work with an agency.
What does IR35 status depend on?
IR35 status depends on some key tests you can use to work out whether you're an employee for tax purposes - these tests usually relate to supervision, direction and control. We go into more detail as part of our IR35 checklist below.
HMRC also has a tool you can use to check whether IR35 applies to a contract (CEST, or the 'check employment status for tax' tool), plus an IR35 helpline.
In reality, IR35 status hinges on IR35 case law and employment legislation, itself reliant on decades worth of employment tests heard in the UK courts.
Another problem is that HMRC's CEST tool may not be entirely accurate, as it doesn't take a key piece of case law (mutuality of obligation, or MOO) into account.
IR35's nuances mean that contractors can't be expected to know the law inside out. You should only use this article as a guide. If you're unsure about anything please seek advice from an IR35 expert - there are many professionals out there who offer contract review services.
Public sector and private sector IR35 rules
There are currently different rules for public sector and private sector contracts.
- for public sector contracts - the hirer is responsible for working out whether the contractor falls inside or outside of IR35. If they fall inside, the hirer, agency or other third party who pays the contractor then needs to deduct tax and NICs and report them to HMRC
- for private sector contracts - the contractor is responsible for working out whether they fall inside or outside of IR35. If they're inside, they need to pay the tax and NICs due
IR35 changes in the private sector in April 2021
Private sector IR35 reform is set for April 2021, when the public sector rules will be applied to the private sector.
This was meant to happen in April 2020, but it's been delayed by a year.
The upcoming IR35 changes mean that:
- medium-sized and large businesses will be responsible for working out the contractor's employment status, not the contractor
- contractors should given the reasons behind the decision, and can dispute the decision if they disagree with it
- small businesses are exempt from the changes - so if the contractor works for a small client, the contractor will still be responsible for working out their employment status
End clients are classed as small businesses if they meet two of the following criteria:
- annual turnover of no more than £10.2 million
- balance sheet total of no more than £5.1 million
- no more than 50 employees
Businesses and contractors should start preparing for the 2021 IR35 changes as soon as possible.
IR35 checklist: am I compliant?
If you're a contractor working out whether IR35 applies to a contract, there are a few principles to consider as part of a checklist.
In general, IR35 won't apply if the contract is for services rather than employment. To untangle that, you should see whether the contract specifically mentions these principles:
- supervision, direction, control - this relates to how much say your client has over how you complete your work. For example, if you have to work at certain times, this implies employment
- substitution - could you bring someone else in to complete the contract, or do you need to do the work yourself? If you can't send someone else, you're likely to be within IR35
- mutuality of obligation (MOO) - is there an obligation on the employer's end to offer work, and do you have to accept it? This is called mutuality of obligation, and if an element of it exists, the contract may fall inside IR35
Supervision, direction, control
For a contract to fall outside of IR35, contractors should have freedom over how they complete their work. A contract that specifies things like the time you can start and finish work, or the days you're required to work, is one that points towards employment.
Other elements of an employment contract that HMRC looks out for include a client overseeing your work excessively, and giving guidance on how to complete it.
Plus, if you're not only providing your services for the agreed job but also working on different tasks as your client sees fit, the contract is likely to be within IR35.
Does your client only want you? For a contract to fall outside of IR35, you should be able to send a substitute to complete the work instead.
This means the contract should state that someone else can provide their services to complete the work. The clause has to be genuine - you should know which skilled contractors you would ask, plus the contract can't be so restrictive that you essentially need to do the work yourself.
Mutuality of obligation (MOO)
This is an important clause to include in a contract, as it's a key test when determining self-employed status.
If the client is obliged to offer work (and pay you) and you're obliged to take it, this demonstrates a contract of employment. In practice, a self-employed contract means working on a project-by-project basis. Once you've completed a project, you're under no obligation to work on further tasks (and the client is under no obligation to offer them).
You should also consider whether you can work for other clients simultaneously. If a client and contract prohibits that, it points towards you being an employee rather than self-employed.
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 our expert IR35 advice