Whether an individual is determined to be outside or inside IR35 will have a significant effect on their tax liability.
In this guide, we explain the IR35 rules and how they impact both workers and employers in the contracting community.
Due to the COVID-19 outbreak, the government has delayed the scheduled changes to the rules surrounding IR35 in the private sector. These will now be introduced on 6th April 2021, a year later than planned.
What is IR35?
IR35 is a piece of tax legislation targeting tax avoidance by contractors operating via a limited company, who should be classed as and, most importantly, taxed like a permanent employee of their end client. Basically, if you are a limited company contractor, working very much like a permanent employee of your client as opposed to having more of a business-to-business relationship, then the Revenue sees it that you should be paying just as many taxes.
How is IR35 status determined?
Put simply, IR35 is determined by using a variety of acknowledged status tests which are based on historic case law, including but not limited to the right to provide a substitute, control, and mutuality of obligations.
The tests are applied to your written contract and working practices in order to provide a view of your engagement on the whole as one of employment for tax purposes, or one of a genuine business agreement.
Supervision, Direction & Control
Are you required to carry out the work yourself, or can you send someone in your place? What degree of supervision, direction and control does your end-client have over what, how, when and where you complete your contract and day to day work?
These clauses should never appear in a contract – to be truly self-employed contractors and freelancers should have control over when and how they work, not the client. Having a project basis to the work performed is an important indicator of IR35 status.
As a contractor, it is likely that you will work to a comprehensive job specification. This specification would outline:
- The services you’ll be providing
- Where those services are provided
- The hours in each day over which the services are provided.
A contract may go further, though, and say that you must submit to management guidance, appraisal or monitoring. If you find yourself in this position, HMRC will probably conclude you are under the control of your client – this will make you, in their eyes, an employee and not a contractor.
Another test of ‘employment’ is whether your business can provide a substitute to do the work. You should be able to send a substitute to complete the work on your behalf or reassign the work. The right to send a substitute, however, must be absolute, and not so restricted that you basically have to perform the work yourself. If you genuinely can provide a ‘substitute’ and on occasion actually do, then the contract is likely to be outside the scope of IR35.
If the client is only interested in your own suitability and skills and no substitute can be offered or accepted, then any substitution clause will likely fail under HMRC scrutiny. If you have to personally provide the services agreed with your client, this is usually an indicator that you’re an employee and aren’t self-employed.
Mutuality of obligation
Is your client obliged to offer you work, and are you obliged to accept it? There are two obligations to consider:
- An obligation for one party to offer work.
- If work is offered, an obligation for the other party to accept it.
Put simply, a contractor must work from project-to-project, with no obligation to carry on working for the client after the work is complete.
A contractor also has the right to terminate a contract part-way through. An employee, on the other hand, can only work for one company and has an obligation to carry on working when their tasks are complete.
You should also check whether the contract allows you to take on projects from other clients simultaneously, or whether the client can veto other assignments.
If the contract specifies exclusivity, and states that you must work a certain number of hours per week at a certain rate on an ongoing basis and requires you to take whatever work the client throws at you, then this would suggest the contract should be inside IR35.
An IR35-proof contract must state the client has no obligation to offer you more work and you have no obligation to take it (this is what is meant by Mutuality of Obligation). Provisions to extend the contract should be avoided.
Other factors to determine outside or inside IR35
Along with the three key areas highlighted above, you need to be aware of the following:
- How you are paid: A contractor will usually receive payment when work is completed, or when project milestones are completed while an employee will usually be paid at regular intervals. If the client requires a weekly invoice, then it should detail work completed during that period as well as hours worked and the rate.
- Alternative work: If you’re contractually obliged to have only one client at a time, you’re probably an employee, not a contractor.
- Equipment: Unless there’s a sound reason (such as for safety, security or practicality), you should be using your own equipment, rather than equipment supplied by your client.
- Premises: The contract should specify where the work will be performed.
- Corporate involvement: You could be affected by IR35 if you have any involvement at all with your client’s corporate structure. This applies to even the smallest involvement, such as whether you have a security pass to your client’s building that does not clearly identify you as a contractor, or whether you appear on company organisation charts.
- Financial risks: Regular, guaranteed weekly or monthly work specified in a contract looks more like an employee ‘contract of services’ rather than professional fees paid to a person who is self-employed. Any errors made by the contractor during the contract must be rectified in the contractor’s own time, and the contract should say this. A requirement to maintain professional indemnity insurance is another indicator that you are self-employed rather than an employee.
- Employee Type Benefits: This includes holiday, sick pay, pension – the contract should state these do not apply. Note that the Agency Workers Regulations (AWR) – which would affect Contractors using Umbrella Companies – mean that Agency Workers are afforded the same benefits as permanent employees – the relationship between AWR and IR35 has yet to be explored.
- Part and parcel: If a contractor becomes so integrated into the client’s organisation that they, for example, appear in organisation charts, or have staff reporting to them, then they are behaving exactly like an employee and the contract could fail IR35. The freelancer or contractor should distance themselves from the client’s corporate structure and only take on responsibilities not specified as part of the project when this is the industry norm, such as, for example, safety responsibilities.
- Intentions of the parties: The contract should always clarify the intentions of the Contractor and client (or agency) to be one of supplier and customer and not employee and employer. The nature of the work should be described accurately. If the intentions of the parties, as expressed in the contract, bear no resemblance to the real intentions of the parties, the written intentions will likely be ignored by HMRC.
- Termination: The contract should state that it will be terminated at the end of the project or if there is a breach of contract.
- Blacklists: Check to see whether your client has had any IR35 problems in the past.
- Other things you should take into account are being able to demonstrate that you are “in business on your own account” – you may not have stock, premises, or staff but you will probably have an office (even at home), a website, be VAT registered, have business stationery, advertising, invoices, insurance and have other clients and an accountant.
If I am ‘inside IR35’, am I operating illegally?
It is not illegal for your contracts to be ‘inside IR35’. Being inside IR35 is considered tax avoidance rather than tax evasion.
If you are considered to be operating ‘within IR35’, then you may need to pay a deemed salary (i.e. higher taxes) which is something you would need to discuss with your accountant. You may need to also consider whether the contract is worthwhile undertaking or if you are just starting out, if the limited company route is the best for you, as your take-home pay may be considerably less.
I fail on one or two of the status tests, does that make me inside IR35?
Not necessarily. Different status tests hold more or less importance than others and that importance may be reliant on different tests, so when we look at a client’s status we look at all the tests as a whole. If you are imagining a definitive checklist of answers to the tests on the wall in our office, you’d be way off the mark, as it is a little more complicated than that. We get a lot of questions which start with how a client may perform on a few of the status tests, followed by “am I inside or outside?”
An employment status specialist couldn’t possibly provide you with an instant answer without looking at everything first.
IR35 considerations for employers
Long-term contractors and freelancers who work through a limited company will need to ensure their contracts accurately reflect the working practices followed in their assignments. Contracts will need to be checked for each assignment on renewal and must provide clear evidence to support your status as a self-employed professional. We have an article “Getting your contracting business ready for IR35‘ that all contractors should read.
HMRC investigations are not confined to the detail contained in an individual contract. HMRC will ‘look beyond’ the contract to examine the working practices you follow with your clients. If HMRC decides the relationship is of an employment nature, they will seek to recover all income tax and National Insurance Contributions due over the period of the assignment involved.
The matters contained in this article are intended to be for general information purposes only. This article does not constitute legal or financial advice, nor is it a complete or authoritative statement of the law and should not be treated as such.
Whilst every effort is made to ensure that the information is correct, no warranty, express or implied, is given as to its accuracy and no liability is accepted for any error or omission.
Before acting on any of the information contained herein, expert legal or other advice should be sought.