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?
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.
Understanding HMRC's IR35 grey zone
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 working practices are saying the same thing.
Contract AND working practices
Always remember that HMRC will be looking at both your contract and your working practices.
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 working practices 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 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 working practices 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.
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. Only hire someone who specialises in dealing with IR35 issues in the contracting sector.
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 businessperson 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
- 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 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 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 can be a convincing indicator of self-employment.
Relying on a single, stable paymaster is characteristic of ordinary employment.
5. Financial records
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, 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.
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 you get everything on point in terms of both your contract and your working practices, HMRC may still assess you as 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.
Changes to IR35: 2020 - 2021
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 NICs before making a payment to you.
If you contract for a public authority, your 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?
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 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 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 that 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?
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. 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.