IR35 tax rules were introduced to reduce the risk of tax avoidance caused by someone working through their own intermediary (such as a limited company), when they would otherwise be considered an employee if the intermediary didn’t exist. In this post we’ll look at:
The IR35 rules (sometimes called ‘off-payroll working rules’) deal with how contractors should pay tax when they operate through an intermediary (usually their own limited company), if without the intermediary they would otherwise work as an employee.
Why was IR35 introduced?
The name ‘IR35’ refers to an early press release announcing the legislation that made these rules law, and this has become shorthand for the topic as a whole. The rules were introduced in order to crack down on potential opportunities for tax avoidance. The easiest way to explain IR35 is to look at how employees pay tax and compare it to how self-employed people pay tax if those rules aren’t in place.
But, what would happen if you were to leave, and then come back a few weeks later to carry out the exact same role but this time through your own limited company?
Rather then being paid through payroll as an employee, you would now submit invoices to your former employer. Your former employer would no longer need to make contributions (such as National Insurance or for your pension) because they’re not paying wages. You wouldn’t have any income tax or National Insurance deducted from your wages either.
Less than 50 employees on average in an accounting year
So, if the business you are contracting with ticks those boxes, then you are clear of IR35. This applies to the whole group though, so if you contract with a small subsidiary of a larger group then you can’t get out of IR35.
Although we are talking primarily about limited companies in the above, the same goes for other types of organisations such as partnerships, charities, and public services.
How does IR35 change my tax status?
In the normal course of business, a limited company does work for a client and then sends an invoice for this. The client pays, and the company accounts for its tax at the end of the financial year.
This is what is generally called an ‘outside’ IR35 contract. As the contractor working through a limited company, you might choose to pay yourself a salary through payroll, take dividends, or a combination of the two.
Where a worker would normally just be the client’s employee, but instead they’re working through their own company, the contract is judged to be ‘inside’ or ‘caught by’ IR35, and the position is different.
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The worker must either become an employee with a fixed-term contract and pay PAYE in the normal way, or they need to make sure that they pay the right amount of tax, and at the right time.
If it’s the latter, the client deducts income tax and employee National Insurance Contributions (NICs), and pays them over to HMRC on the employee’s behalf along with an employer’s contribution. Just like an employer would.
This is a fundamental change to the tax laws, because until now it has always been the taxpayer’s responsibility to assess their own tax status and ensure that their tax is correctly paid. Under IR35, that burden passes to the employer.
How do you know if you are ‘caught’ by IR35?
Known as a ‘determination’, this is a formal way of recording the thought process that goes into assessing your tax status. In general, clients will have made an interim assessment of the role before advertising, so you may well see ads that state whether it is inside or outside IR35.
However, some of the tests relate to the individual. Even though a role might initially look like it is outside IR35, there may be circumstances (if you already work for them, for example) where the determination may change.
Once they make a determination, the client must give you a copy showing what the determination is, and how they arrived at it.
What are the IR35 tests?
Since the start of IR35, HMRC has tried to devise a simple method of telling whether a role should be inside IR35 or not, and this has met with limited success.
The problem is that contracting is so diverse that a test that seems reasonable for one company completely falls down when tried with another organisation.
The issue is so complex that HMRC regularly loses tribunals based on their own rules! However, there are some tests which give a good general indication, such as those below.
Exclusive services and length of engagement
Is the client justified in expecting the contractor to only work for them? Will the contract last for more than two years?
The intention of the Two Parties
Is the intention of the two parties to create an employer/employee relationship?
Mutuality of obligation
Does the employer have an obligation to provide more work for the contractor to do and is the contractor obligated to do it?
Right of dismissal
Does the client have the right to dismiss the contractor?
Is the contractor acting as a business?
Basis of payment
Does the person receive a salary or hourly rate?
Provision of equipment
Does the client provide all, or a substantial part, of the equipment necessary to do the job?
Personal service and substitution
Can the client refuse to accept a substitute contractor?
Is the contractor under the direct control of the client manager?
Does the client accept the financial risk of the contract?
Part and parcel of the organisation
Is the contractor acting like they are part and parcel of the organisation?
Some of these tests are simple and easy to evidence. For example, if you have business stationery printed, maintain your own website, or spend money on advertising for work then that would be business-like.
There’s an over-arching rule that we like to apply here, and it is the duck rule. In other words, if it looks like a duck, walks like a duck, and quacks like a duck – then it probably is a duck!
If your contract looks like an employment contract
And you are acting like an employee
And your client is treating you like an employee
Then you are probably an employee and should be taxed within IR35.
Of course, the main problem is that this isn’t an exact science, as proven by the fact that HMRC has an unenviable record of losing tribunal cases and appeals. The main message here has to be to take advice, even if you think you’re sure.
Can you appeal against an IR35 determination?
Yes, you can, although that might not be massively helpful. Once you have the determination then you have the right to appeal. There is a practical note to bear in mind here though.
Let’s first say that organisations must not use a blanket approach. If your client tells you that you’re inside IR35 because they treat all their contractors that way, then this is a clear breach of the rules.
In the real world, contractors can be brought in at short notice to start a role urgently. How enthusiastically will a client go through a determination appeal when there are plenty more candidates around?
This shouldn’t be a consideration for contractors but in truth, we can imagine that clients won’t be keen to go through an appeal process when they can simply appoint someone else. It’s a difficult position for contractors, which sadly doesn’t leave you much room to negotiate.
Summary: IR35 for contractors
IR35 was an attempt to cut down on tax avoidance by contractors in a variety of sectors and has now been around in various forms for more than two decades.
It is now the employer’s duty to assess the status of any contractors to ensure that they don’t fall within IR35 and if they do, to pay over tax and NIC contributions.
In short, IR35 is complicated, very complicated. As a result, it’s crucial for contractors and employers alike to make sure they are on the right side of the law.
If you are an employer and you are thinking of using contractors, then you absolutely do need to get help to understand how you should be paying them. If you are a contractor, or you are thinking about going into contracting, then you need to understand the tax rules before you start.