IR35 and off-payroll working rules can be confusing, but it’s important that contractors and their clients understand the processes and rules.

What are the IR35 rules?

IR35 legislation deals with contractors, who would otherwise be employees if they weren’t working through an ‘intermediary’. The intermediary could be the contractor’s own limited company, or a partnership. If a contractor is essentially working as an employee, then the contract is ‘within IR35’.

That means that the IR35 rules apply, and the end client must deduct income tax and National Insurance Contributions for the contractor as if they were their employer.

Jargon buster: Personal service company

The phrase ‘personal service company’ describes limited companies set up to act as an intermediary, because they exist for the contractor to provide services to clients.

An example of how it works without IR35

It’s a bit confusing, so we’ll give you an example. Imagine you work for an employer, and then leave to set up your own limited company.

You continue performing the same function for your former employer (basically doing the same job), except now you work through your own business, rather than being on their payroll.

Without IR35:

• The employer effectively has the same employee back, but doesn’t have to pay employer’s NI, pension contributions, sick pay… and so on. It’s cheaper for them, but means the worker loses the benefit of those contributions, so IR35 protects employees from being forced into this arrangement.
• The contractor gets paid by invoicing the business, so won’t have income tax or NI deducted by their employer. The contractor can then pay themselves from their company, using a more tax efficient combination of salary and dividend payments. IR35 legislation closes this loophole.

Off-payroll working: Who decides whether IR35 rules apply or not?

This is what the rules for off-payroll working deal with; whose responsibility it is to check if IR35 rules apply in a particular situation. The process is also known as ‘determining someone’s employment status for IR35’.

Off-payroll rules were originally introduced in the public sector, and were then implemented for the private sector from 6 April 2021.

In short, the off-payroll rules mean that it’s up to the end client to work out the employment status and whether a contract is within IR35, but only if the end client is a public authority or a private company which meets two or more of these conditions:

• It has an annual turnover of more than £10.2 million
• The balance sheet total is more than £5.1 million
• The client has more than 50 employees on average in an accounting year

Issuing a Status Determination Statement (SDS)

If the client meets the criteria, it’s up to them to determine the worker’s status. They’ll issue a Status Determination Statement (SDS) which indicates why the engagement is within (or outside) IR35. The SDS is given to the worker, as well as to any person or organisation the client contracts with.

What if the client doesn’t fit those criteria?

If the client doesn’t meet the off-payroll criteria (so they’re a small, private company, or they’re based abroad with no UK connection) then it’s the intermediary’s responsibility to decide whether or not the contract falls within IR35 rules.

• HMRC have an online tool to assist with this, known as the Check Employment Status for Tax (CEST) tool.

If CEST is used to determine the employment status of an engagement, HMRC will honour the outcome as long as the correct information has been entered. So, keep the evidence!
 

What happens if a contract is inside IR35?

If the end client find that the worker would be treated as an employee if the intermediary didn’t exist, the contract is ‘inside IR35’.

Where a contract is inside IR35, the entity that pays the intermediary will deduct income tax and employee National Insurance Contributions (NICs) from their payments. They’ll pay these to HMRC on behalf of the worker (like they do for employees), as well as making employer’s NICs.

In some circumstances the client still pays the gross amount (so they don’t deduct tax or NI), and the intermediary’s payroll makes the deductions instead, with the worker themselves then paid as if they’re employed.

Can contractors still operate through a limited company?

There’s no rule to say that you must close your limited company if you’re a contractor, but if your contract does fall within IR35, your client will deduct tax and NI at source.

Instead, you might decide to:

• Become an employee, rather than working as a contractor for a client
• Use an umbrella company (which we explain further on)
• Become a sole trader, and stay outside of IR35 entirely, both for tax/NI reasons, and to avoid the complexity of IR35 itself.

Is it better for me to be employed by my client instead?

Becoming an employee may be good for contractors already treated as inside IR35 when working for a client, but it’s not for everyone.

IR35 will no longer be an issue, with income taxes and NICs deducted by the employer at source. Employees also have additional employment rights, including:

• Statutory sick Pay Statutory maternity/paternity/adoption leave
• Minimum notice periods and protection against unfair dismissal
• Statutory redundancy Pay – may require a minimum period of continuous employment.

The flipside of this is the loss of flexibility, non-competition clauses in employment contracts, and that some businesses may simply prefer not to be an employer.

What about an Umbrella Company?

An Umbrella Company acts as the contractor’s employer on behalf of an employment agency, operating PAYE and making the appropriate deductions.

They can also offer full employment rights and benefits, and the contractor will pay the umbrella a fee for its services. However, not all umbrella companies are compliant, and as a result some companies won’t work with them.

Becoming a sole trader instead

If the sort of work you do will usually be considered to fall within IR35, it might be more tax efficient for you to operate as a sole trader, instead. This is because sole traders aren’t legally separate from their business in the way that a director is with their limited company.
 

 
As a result, it means they pay tax and NI on all their profits, rather than on the money they pay themselves from the business. This means the loophole which IR35 closes isn’t available to sole traders anyway, so they aren’t subject to IR35 rules. It might mean that operating as a sole trader is more tax efficient than contracting through your own limited company if your work falls within IR35.

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About The Author

Dean Salmon

I'm an AAT and ACA qualified Chartered Accountant with over 13 years experience working with businesses, contractors and sole traders. I also love watching live music, and quizzes!