Tax

IR35 and its Impact on Independent Contractors

Our guide covers what is IR35 and what it means for contractors and their employment status. It also explains how you can structure your working arrangements to avoid falling into IR35.

By

Chris Andreou

City in which IR35 was established by HMRC

What is IR35?

IR35 is a piece of legislation which allows HMRC to treat private contractors as if they were employees. In other words, IR35 (also known as "Off-Payroll Working Rules") aims to determine if someone working in the private sector should be classified as an employee - something that can impact tax liability and national insurance contributions.

IR35 was introduced to combat the problem of "disguised employment", where employees offer their services as limited company contractors to pay less income tax and National Insurance.

Prior to April 2017, individual contractors working in public sector businesses were responsible for determining their own IR35 status. They were also responsible for paying the appropriate taxes and National Insurance contributions. However, from April 2017, the responsibility for assessing and determining IR35 status shifted from the individual contractor to the public sector organization or agency that engages their services.

In the private sector, it was also the responsibility of contractors to determine their own IR35 status and comply with the tax regulations. From April 6, 2021, though, the responsibility has shifted to the private sector client.

How Does IR35 Work?

Under IR35, HMRC assesses the working relationship between the contractor and the client to determine the contractor's tax status. If a contractor is found to be a "disguised employee" of the client, they will be subject to PAYE (Pay As You Earn) tax and National Insurance Contributions (NICs) just like a regular employee.

Factors that HMRC considers to establish employment status include the level of control the client has over the contractor, the mutuality of obligation, the right to substitute, and financial risk, among others.

What Does Inside IR35 Mean?

When a contractor or freelancer is deemed to be "inside IR35," it means that, according to HMRC's assessment, the individual's working relationship with a client is similar to that of an employee rather than a genuine self-employed contractor.

Key characteristics of a working arrangement classified as "inside IR35" include:

  1. Control and Supervision: The client has a significant degree of control and supervision over the contractor's work, resembling an employer-employee relationship.
  2. Mutuality of Obligation: There is an expectation that the contractor will be offered work and the client is obligated to provide it, resembling an ongoing employment relationship.
  3. Integration: The contractor is integrated into the client's organization, participating in meetings, using company equipment, and working as an integral part of the team.
  4. Substitution Rights: The contractor does not have a genuine right to send a substitute to perform the work on their behalf.
  5. Financial Risk: The contractor does not bear a significant degree of financial risk, such as investing in their own equipment, covering business expenses, or being responsible for rectifying unsatisfactory work at their own cost.

When a contractor is classified as "inside IR35," the client or hiring organization is responsible for deducting income tax and National Insurance Contributions (NICs) from the contractor's earnings before paying them. The contractor essentially receives the net pay after these deductions, similar to how a salaried employee receives their pay. This tax treatment is intended to prevent tax avoidance by individuals who, according to HMRC, should be taxed as employees based on the nature of their work.

What does outside IR35 mean?

"Outside IR35" is a tax status used to classify a working relationship where an individual, typically a contractor or freelancer, is considered to be genuinely self-employed and operating in a manner independent from their clients. When a contractor is deemed to be "outside IR35," it signifies that their working arrangement with a client is viewed by HMRC as similar to a genuine business-to-business relationship, rather than an employer-employee relationship.

Key characteristics of a working arrangement classified as "outside IR35" include:

  1. Control and Supervision: The contractor has a higher level of control and autonomy over their work without constant supervision from the client. They can dictate how, when, and where they perform their tasks.
  2. Mutuality of Obligation: There is no expectation that the client must offer work, nor is the contractor obliged to accept work when offered. The relationship is project-based and not ongoing.
  3. Integration: The contractor is not integrated into the client's organization, maintaining a separate identity and working independently.
  4. Substitution Rights: The contractor retains the right to send a substitute to perform the work on their behalf, providing flexibility and demonstrating a genuine business structure.
  5. Financial Risk: The contractor bears a significant degree of financial risk, such as covering business expenses, investing in their own equipment, and being responsible for rectifying unsatisfactory work at their own cost.

When a contractor is classified as "outside IR35," they are responsible for managing their own tax affairs and do not have income tax or National Insurance Contributions (NICs) deducted at source by the client. Instead, they receive payments in full for the services they provide and are accountable for paying taxes directly to HMRC through self-assessment tax returns.

Will it affect me?

This off-payroll legislation is usually a threat to your income only if you are self-employed, and provide your services via a limited company.

HMRC may decide that you should, in fact, deduct income tax and NI contributions as if you were an employee working in the private sector or public sector.

Use Inside vs Outside IR35 Assessment Calculator to know your employment status and assess the impact the legislation has on your net income.

What would that mean?

If your contract is found to fall within IR35, then the difference in take-home pay usually amounts to around 20%.

But that's not all.

HMRC may choose to investigate previous contracts going back at least 6 years to see should also have come under the off payroll working rules of IR35. So this could mean a higher income tax bill and a bulk payment for previous unpaid income tax, plus penalties and interest.

How to Avoid IR35?

You need to structure your private sector contracts and working arrangements in such a way that they fall outside off payroll working or IR35.

Your objective is to stop any enquiry by HMRC before it has a chance to get off the ground. This is usually not that difficult to do, but the process is technical and a bit complicated.

If you are a legitimate contractor trying to make your way through a busy year without falling foul of HMRC's complicated IR35 legislation and obscure assessment process there is a clear and straightforward action plan below.

IR35 guide for independent contractors

IR35 is a piece of legislation which allows HMRC to treat private contractors as if they were employees.

It was introduced to combat the problem of "disguised employment", where employees offer their services via limited companies to pay less tax and National Insurance.

Will it affect me?

IR35 is usually a threat to your income only if you are self-employed, and provide your services via a limited company

HMRC may decide that you should, in fact, be paying tax and NI contributions as if you were an employee. 

What would that mean?

If your contract is found to fall within IR35, then the difference in take-home pay usually amounts to around 20%.

But that's not all.

HMRC may choose to investigate previous contracts going back at least 6 years to see if they should also have come under IR35. So this could mean a higher tax bill and a bulk payment for previous unpaid tax, plus penalties and interest.

What do I need to do?

You need to structure your contracts and working arrangements in such a way that they fall outside IR35.

Your objective is to stop any enquiry by HMRC before it has a chance to get off the ground. This is usually not that difficult to do, but the process is technical and a bit complicated.

If you are a legitimate contractor trying to make your way through a busy year without falling foul of HMRC's complicated IR35 legislation and obscure assessment process there is a clear and straightforward action plan below.

IR35 guide for independent contractors

Understanding HMRC's IR35 grey zone

The basics

Let's start with the basics: why is IR35 so complicated and so ambiguous?

It's complicated because there is no simple checklist of things HMRC looks for to make their assessment.

But they will look at many different details in your contract and will also look at your working practices in fine detail. Here is the full list of what HMRC will look through when assessing IR35

It's ambiguous because HMRC will not make their assessment on the basis of those details directly but on the basis of an "overall picture" which emerges from those details. As the saying about beauty and the eye of the beholder implies: not everyone ascribes value in the same way.

To quote from HMRC's guidance to determining IR35 status:

"The object of the exercise is to paint a picture from the accumulation of detail. The overall effect can only be appreciated by standing back from the detailed picture which has been painted, by viewing it from a distance and by making an informed, considered, qualitative appreciation of the whole.

"It is a matter of evaluation of the overall effect of the detail, which is not necessarily the same as the sum total of the individual details."

You will make HMRC's job much easier if you understand how they go about formulating their assessment. This enables you to give them the evidence they require in a way that is unlikely to be misinterpreted or misunderstood.

One of the easiest ways to avoid misunderstandings is to ensure that both your contract and your work approaches are saying the same thing. 

Contract AND working practices

Always remember that HMRC will be looking at both your contract and your work approaches.

If your contract is deemed not to be comprehensive, then HMRC will build what they deem to be a properly comprehensive picture by including relevant details from your working practices.

According to case law and legal precedent, if HMRC believes your contract to be both genuine and comprehensive then they are required to base their decision on the contract alone. In reality, they also always look at your working practices first to ensure your contract is not a sham.

What this means is that if your work approaches are characteristic of employment, then you will be included within IR35 on that basis—whatever your contract might say. 

However, if your working practices are an accurate and true reflection of your contract terms (and hence your contract is not a sham) then you still cannot relax: you may still fall within IR35 on the basis of legal technicalities contained within or omitted from your contract.

IR35 guide for independent contractors

IR35 action plan. Part 1: right now, or before you begin

Although IR35 is both complicated and ambiguous, its essence is simple: you need to look like a private company and not like an employee.

The first thing to do is to move into place the factors able to influence your case the most.

There are four things you can do right now which are easy, powerful and will set you on the right path.

1. Secure a clear right of substitution

Substitution means you can send someone else in to do your work, at your own decision and expense.

Provided the right of substitution is clearly and tightly defined as laying in the contractor's hands, then the legal precedents make it a very effective defence. Your client cannot exercise any significant control (such as right of approval) over who you choose to replace you for this defence to work well.

Ensure that you have a right of substitution clause included in your contract. Even better, actually use this right during your contract's duration.

2. Include a statement of intention in your contract

HMRC may deem your contract or working practices to be ambiguous. You look like a private company but you also do some things in a way that makes it look like you are an employee. You might fall within IR35 or you might not.

If you include a "statement of intention" in your contract, you will not be included within IR35 when there is ambiguity.

Without such a statement of intention in your contract HMRC is required to interpret the ambiguity in your case as it deems most correct.

This is not an effective defence if your contract or workpproas are unambiguous, and you clearly look like an employee.  

3. Secure a "confirmation of arrangements" letter from your client

In all IR35 cases the courts have made it clear that they require evidence from the client 

The value of a confirmation of arrangements letter has been well-established. Provided it is correctly structured, you can use it to very quickly close down any enquiry into your IR35 status by HMRC.

A confirmation of arrangements letter can also be used if you work for an agency, and are unsure if the agency-client contract itself (which it is unlikely you will get to see) is IR35-compliant. Or you may have already signed a contract which could be interpreted as ambiguous.

A confirmation of arrangements letter should clearly state why your working arrangements fall outside of IR35. It should also record that every party in the contractual chain agrees on the IR35 status of the contractor.

This is an area where it is worth paying for professional advice.

Here is a sample template for a confirmation of arrangements letter.

4. Get your contract professionally reviewed for IR35 before you sign it

You have to be certain that your contract does not contain mistakes, inconsistencies or omissions which could inadvertently land you inside IR35.

If you have to provide your own contract, then at the very least use a professional template and submit your final version for professional review. If your client provides the contract then make sure to have it professionally reviewed sufficiently early to allow time for negotiations.

IR35 is a complex area of case law and an ordinary solicitor is unlikely to have the expert knowledge needed to identify and resolve potential issues. Hire expert contractor accountants who specialise in dealing with IR35 issues in the contracting sector.

independent contractor guide to IR35

IR35 action plan. Part 2: next, build a comprehensive and clear picture

Whilst professional advice is essential when drafting your paperwork, you also need to personally understand what is involved and how to approach it. This enables you to be consistent in your working practices.

Knowing what to look for in a proposed contract also enables you to recognise whether you need to negotiate different terms.

Here's what you always have to keep in mind, starting with the most important factor: control.

1. Ensure you are a free business person not a controlled employee 

Control used to be the defining factor for determining whether someone was an employee or genuinely in business on their own account. Even today, most other factors in your contract will be interpreted through the lens of control.

If the only controls that your client can exercise over you are that the work must be completed by a certain deadline and to a sufficient standard, then it is likely you will be classified as an independent contractor.

It can also help you to be classified as falling outside of IR35 if you are:

  • responsible for your own training and expenses as a self employed person
  • free to do your work wherever and whenever you want
  • able to decide for yourself how the work is to be done

Examine the other terms in your contract and ensure that they do not give your client a level of control over you that could be interpreted as an employer/employee relationship.

You are likely to be classified as falling within IR35 if your contract gives your client the right to:

  • monitor your self employed work on a continual basis
  • expect you to follow instructions in the same way an employee would
  • control your working methods
  • have you subject to a line manager

More flexibility exists as regards when and where the work is done but you still need to be careful. For example, the inclusion of lunch break times and duration in a contract would be indicative of an employment relationship.

Generally speaking, the greater the control, the more likely it is that HMRC will view the contract as one of employment.

2. Mutuality of obligation

This is a key test but case law has shown that HMRC is prone to misinterpreting or misunderstanding what is involved. As such it is not worth making this factor a main part of your argument.

Keep it simple: you want to ensure that you are not obliged to accept self employment contracts and that your client is not obliged to offer them.

If work is repeatedly offered and repeatedly accepted then HMRC may take the view that an employment contract has been created "by custom and habit". In practice, this is most easily offset by securing contracts from several different clients.

3. Exclusive service

If your contract explicitly states that you are not allowed to provide your services to other clients, then you will likely fail assessment.

Clauses can however be included to preclude you from working for competitors or where another conflict of interest would be created.

4. Financial risk

Creating risk and uncertainty around how you are paid as a self employed person can be a convincing indicator of self-employment. 

Relying on a single, stable paymaster is characteristic of ordinary employment.

Another thing to keep in mind is that your determination of employment status does not directly impact the need for public liability insurance or professional indemnity insurance, but it does have implications for tax and National Insurance contributions.

5. Financial records

Self employed contractors are usually paid on completion of a contract, employees at regular intervals. 

Contractors also usually issue an invoice for their services. Be careful though: this factor is often inconclusive and should not be relied upon as the main feature of your argument.

6. Business-like trading

An independent contractor should have all the trappings of a normal business: a registered limited company (if they are limited company contractors), a business bank account, VAT registration, expenses for things like office equipment and advertising and so on.

7. Provision of equipment

You need to provide and use your own equipment where practical.

If there are good reasons as to why you need to use your client's equipment, such as safety or security concerns, then this factor will not normally cause you to fail an assessment as self employed.

8. Part and parcel

You need to keep your distance from your client's organisational structure, and only fulfil the obligations which are in your contract. Also, do not use facilities normally reserved for staff such as a staff car park, gym or canteen.

If you start appearing on telephone lists and organisational charts, then you may be classified as "part and parcel" of your client's organisation. In which case you would fall inside IR35 no matter what your contract says.

This is an easy IR35 test to fail, and you need to be careful with your working practices on this score.

9. Appraisal of personnel

If you appraise personnel within your client's organisation or allow yourself to be appraised, then you will likely be viewed as part and parcel of your client's organisation.

Appraisal is for employees, not contractors.

10. Be careful who you work for

Even if a person gets everything on point in terms of both their contract and their working practices, HMRC may still assess them as disguised employees falling within IR35.

This is because if the client organisation you are working for as a contractor has previously been found to have used "disguised employees" then HMRC can insist that all future contractors be automatically treated as employees.

In such an instance ,neither your contract nor your working practices will make any difference. The only way to dispute such a decision is through court proceedings.

To repeat, HMRC does not even have to look at your contract in this instance.

What are the Changes to IR35? 2020 - 2021

Same criteria

None of the assessment criteria for determining whether a contract is located within IR35 will change with the IR35 reform (now set for April 2021). All of the recommendations given above will still hold.

The name of the game will remain making sure you look like a limited company rather than like an employed individual. And it will still be the overall picture of your activities that you have to watch out for.

What will be changing is who gets to decide your IR35 status

Due to the COVID-19 outbreak, a one-year delay to the new IR35 Off-Payroll Working rules has been announced. Up until 6 April 2021, contractors and private service companies will remain responsible for determining their status.

The following will apply for all services provided on or after 6 April 2021, regardless of when the contract started:

If you contract for a medium or large-sized non-public sector organisation (companies with more than 50 employees or a turnover greater than £10 million), your client will be responsible for deciding your employment status. If the rules apply, they’re required to provide you with a ‘Status Determination Statement’ that details and explains their decision. 

If your contract is deemed to be inside IR35, you’ll be considered an employee for tax purposes. As such, your agency or client will deduct Income Tax and National Insurance contributions before making a payment to you.

If you contract for a public authority, your public sector client will continue to be responsible for deciding your status. In addition, they will now need to provide you with a ‘Status Determination Statement’ that declares your deemed employment status, and the reasoning for their decision.

If you contract for a small non-public sector organisation, your limited company will continue to be responsible for deciding your status, as well as paying the relevant Income Tax and NICs.

According to the Companies Act 2006, a small business is an organisation whereby two or more of the following factors apply:

  • Turnover of £10.2m or less
  • A balance sheet total of £5.1m or less
  • 50 employees or fewer

IR35 Changes: FAQs

What are the responsibilities of the end-client?

The end-client will be responsible for deciding a contractor’s employment status. This must be carried out with ‘reasonable care’.

They’re responsible for:

  • Providing a Status Determination Statement (SDS)
  • Giving the SDS to the worker and the party you contract with—such as the personal service company (PSC) or agency. Where there is more than one agency in the supply chain, it will be the responsibility of the agency receiving the SDS from the end client to pass it down to the next agency in the chain, and so on.   
  • Keeping detailed records of the determinations and reasons for them
  • Introducing a status disagreement process that enables the worker or deemed employer
  • Providing a response within 45 days of receiving notification that the worker or deemed employer raises a disagreement
  • Informing the worker and deemed employer if they become a small company

What is a Status Determination Statement (SDS)?

A Status Determination Statement is a document that declares a contractor’s IR35 status, and the end-client’s reasoning for their decision. It serves to combat non-compliance and misclassification of a worker’s status due to blanket determinations.

What are steps I can take if I disagree with a client’s assessment?

Presently, contractors may contest HMRC's IR35 determination through an Alternative Dispute Resolution or IR25 tribunal.

However, once the IR35 reform kicks in, you'll need to appeal through your client’s status disagreement process.

Your client will have 45 days to respond, in which they could either change the determination and provide a new statement, or confirm that their initial determination was correct along with providing reasoning for their decision.

What if I am contracting for multiple clients?

If you are contracting for multiple clients in the private sector, IR35 will apply, regardless of the number of clients or projects you’re working on.

Your status is evaluated on an assignment basis. This means that you may find that one of your private sector contracts may be deemed to fall inside IR35, others may not.

If I am deemed to be inside IR35, will I benefit from employees’ rights?

If your contract is deemed to fall inside IR35, you will be taxed as an employee, but you won’t qualify for statutory employment rights such as holiday pay, sick pay, pension contributions and more.

I was planning to set up a limited company. What do these changes mean for me?

You may be wondering if you’re better off being a full-time employee, or question your chances of landing contracts in the private sector as a limited company contractor. 

Before you make a decision, it’s best to consult your accountant. They will be able to explain how you’ll be impacted, run you through the different options you have and point you towards working methods that work best for you.


What you can do to prepare

Follow the IR35 advice as given above. We have already decoded HMRC's process for you, and our specialist legal advice works no matter who is taking the decision. 

Whoever takes the decision will still be contracting for your services via your limited company. You still need to structure your contract terms intelligently and with an eye to IR35 legislation. You still need to ensure your working practices are in alignment with those contract terms.

What does change is the value of a Confirmation of Arrangements letter from your client. You can even secure this before you agree to take on the contract.

Have a discussion with your client or agency well ahead in advance. In doing so, you’re sending across the message that the upcoming changes are important. You’ll also get to find out about your client’s or agency’s plans for the reform, which will help you prepare for any upcoming changes.

Plan ahead and explore other alternatives. Reading our article and other guides in our contractor resource hub is a great first step to understanding the new IR35 changes.

Next, you should plan ahead, and think through important questions such as: if your contract is deemed to fall inside IR35, what would be the minimum rate you would charge? And would working through an umbrella company be an option you’d consider? (Working through an umbrella company can offer benefits such as simplified tax compliance, employment benefits, professional support and guidance, and insurance coverage).

What to do if a contract does fall within IR35

You then need to treat the income from that contract as ordinary employment income, taxable under Schedule E and subject to Class 1 NICs.

Your income from other contracts which do not fall within IR35 is still assessable under Schedule D and subject to Class 2/4 NICs.

Just because one of your contracts does fall within IR35 does not mean that they all will or that all your income tax will be subject to it. only if it is located within IR35 then you have to treat as such.

Not attracting HMRC's attention in the first place is even better than having a good defence. For the same reason ensure you do not file any late tax returns, and consider employing an accountant to submit your paperwork for you.

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