What is IR35 and what does it mean for contractors and businesses

Jeremy Hunt’s announced scrapping of the planned reversal of IR35 reforms and other tax measures has dashed the hopes of thousands of self-employed contractors along with the businesses they work with. 

IR35 rules have been controversial for years. These off-payroll working rules were designed to combat tax evasion, but many businesses and contractors have felt that IR35 added unnecessary complexity to flexible employment.  Former Chancellor Kwasi Kwarteng announced that the IR35 rules would be scrapped for private sector contractors in his Autumn budget, but for now that plan  are no longer on the cards. 

As such, contractors will still have to prove to HMRC that they are not Disguised Employees. 

IR35 is a set of regulations aiming to tax workers who provide their services through an intermediary, such as a personal service company (PSC), at the same rate as if they were client employees. While self-employed contractors do not enjoy the same employment benefits (like sick pay or annual leave) or employee rights as their employed counterparts, they enjoy tax benefits. IRP35 rules were designed to reduce tax avoidance and ensure that contractors working for a client (but whose actual working practices make them employees) pay the same tax and national insurance contributions as employees should.

The rules apply to workers who would be classed as employees if they provided their services directly to the client but chose to work through an intermediary. This includes sole traders, limited companies and partnerships.

A status determination statement is simply a written statement put together by the decision-maker, the end client, stating the employment status of a contractor following an IR35 assessment conducted with reasonable care.

If IR35 catches a worker they believe is not genuinely self-employed, they will have to pay employment taxes - including income tax and national insurance - on top of any fees their intermediary charges.

The rules have been controversial since they were introduced in 2000, with many contractors arguing that they are unfairly targeted and disproportionately complex.

Under the current system, clients must assess whether or not a contractor should be taxed as an employee. If a client believes a contractor should be taxed as an employee, it is then up to the contractor to prove that they are not a Disguised Employee.

During the initial announcement of the scrapping of the rule, the government stated that this system puts "unreasonable burdens" on businesses and individuals and that scrapping it will save businesses £350 million annually in "reduced compliance costs". 

With the rules firmly in place once more, some feel that the administrative burden IR35 places on employers will impact the income of the self-employed. 

IR35 rules will not apply if the contract the limited company or contractor entered into is for services and not employment. You can determine whether or not someone has self employed status by examining the following:

Supervision, direction and control

If the client has a say over the working times of a contractor, this may imply that they are employees.

Substitution

If a contractor can be replaced or another person brought in to complete the contract, you are likely operating outside IR35.

Mutuality of Obligation

Is there an obligation from the employer to offer work and an obligation to accept it? If there is a mutuality of obligation, the contract likely falls outside IR35.

Other criteria that could determine IR35 status

• If the worker brings their own equipment instead of the client's, they are likely not an employee.
• Self-employed contractors take on some financial risks, like most small businesses. Are they responsible for correcting errors? Do they have professional indemnity insurance? If not, they are likely inside IR35.
• The way an employee is paid by the end client can determine their IR35 status. If they are paid on a project by project basis, they are probably not employees.
• If these skilled contractors are so ingrained in the company that they are referred to as employees, this may point to their employment status as being inside IR35 and that they should be paying tax accordingly.
• If the contractor works for multiple clients or more than one client at a time, it points to self employment. If a person works for one client, they may be inside IR35.
• If the relationship with the end client points to one of supplier and customer, the person is likely a self employed contractor and not an employee.
• If the contractor is running their business as a business, complete with their own office space and employees of their own, they will fall outside IR35.

Suffice to say the announcement of the scrapping of the IR35 reforms have been met with criticism. The director of IPSE (the Association of Independent Professionals and the Self-Employed), Andy Chamberlain, has called the decision “spineless” and expressed fears that the decision will lead to more work being offshored and more contractors operating through unregulated umbrella companies.

Contractors and employers are no doubt dismayed by the decision not to scrap IR35 rules for good. Hopefully, bringing IR35 back into the spotlight will renew interest in reforming the policy and lead to positive changes down the line.