IR35 - what it is, and why it might matter to you
IR35 is legislation brought in by the Government in April 2000, to counter what HMRC class as a "disguised employment".
For example, if a permanent employee were to leave their company on a Friday afternoon then return to work on the Monday, at the same company, doing the same job role, but as a contractor rather than a permanent employee, that is likely to be classed as "disguised employment".
So what does IR35 say?
IR35 is also known as ‘intermediaries legislation’. It’s a set of rules that affect your tax and National Insurance if you’re contracted to work for a client through an intermediary. You may need to follow IR35 if you work for a client through an "intermediary".
The intermediary can be:
- your own limited company
- a service or personal service company
- a partnership
If IR35 applies then the intermediary has to operate PAYE and National Insurance contributions on any salary or wages it pays to you during the tax year.
The rules are designed to make sure that the right rate of tax and National Insurance is paid for you.
IR35 may also apply if you’re working through an intermediary and you:
- or your intermediary, or client are abroad
- work in the construction industry
- are an office-holder (e.g. a Company Director)
- work with your partner or spouse
- are working, through an intermediary, for a charitable organisation
IR35 doesn’t apply if you work for a client through a Managed Service Company (MSC) or agency, for example an employment agency.
There’s more detailed information about the IR35 conditions of liability in the Government's Employment Status manual.
What difference might it make?
If IR35 applies to you, then you will have to pay full tax and full National Insurance (instead of the usual salary and dividends from the profits of your company) and reduced expenses i.e. you’ll earn less money.
This is because HM Revenue and Customs believes that as you aren’t taking the financial risks or have the same level of control as a director of your own limited company, you aren’t entitled to the same corporate tax structure.
How do I know if IR35 applies to me?
HMRC have published an online tool to check whether IR35 applies; you can use this to find out if you, or a worker on a specific engagement, should be classed as employed or self-employed for tax purposes.
The service will give you the view of HMRC on whether the intermediaries legislation (IR35) applies to an engagement and whether a worker should pay tax through PAYE for an engagement. It can be used for current or future engagements in the private or public sector. HMRC have said they will stand by the result given unless a compliance check finds the information provided isn’t accurate. HMRC won’t stand by results achieved through contrived arrangements designed to get a particular outcome from the service. This would apparently be treated as evidence of deliberate non-compliance with associated higher penalties. You should choose answers that best match the usual working practices of the engagement.
The service is anonymous and won’t store any information you enter or the result given. You’ll be able to print your result for your own records. Try it now >>
If you'd rather understand the whole thing, read on....
You might imagine deciding if IR35 applies would be a fairly straightforward process - ‘If I have a limited company and the work isn’t permanent I’m therefore a contractor.’ Well, unfortunately it isn’t that black and white, and there’s a variety of questions you should ask to gauge your true status. It’s important to remember that there is no definitive ‘rule’ to IR35 and if you can convincingly justify your reasons you won’t be placed on Payroll as an employee.
HMRC are becoming increasingly tough with regards to IR35 enforcement - particularly in the Public Sector. This makes it even more important that you’re able to substantiate your claim as a legitimate contractor.
The first thing to consider when approaching IR35 is whether your work is controlled and directed by you, or if you are subject to an employer / employee relationship.
In fact, when you are contracted to provide a service through your limited company, you need to consider if you have simply replaced another worker who was an employee. If you have, then you are likely to be caught by IR35, as your limited company is disguising the conduct of your duties as an actual employee.
There is a lot of guidance from HMRC on the application of IR35 to limited companies, and the main checklist is given below: (see https://www.gov.uk/employment-status/employee and also https://www.gov.uk/guidance/ir35-find-out-if-it-applies). HMRC also offer a contract review if you're not sure about whether you're caught by IR35.
As far as HMRC are concerned, someone who works for a business is probably an employee (and therefore “caught” by IR35) if most of the following are true:
- they’re required to work regularly unless they’re on leave, eg holiday, sick leave or maternity leave
- they’re required to do a minimum number of hours and expect to be paid for time worked
- a manager or supervisor is responsible for their workload, saying when a piece of work should be finished and how it should be done
- they can’t send someone else to do their work
- the business deducts tax and National Insurance contributions from their wages
- they get paid holiday
- they’re entitled to contractual or Statutory Sick Pay, and maternity or paternity pay
- they can join the business’s pension scheme
- the business’s disciplinary and grievance procedures apply to them
- they work at the business’s premises or at an address specified by the business
- their contract sets out redundancy procedures
- the business provides the materials, tools and equipment for their work
- they only work for the business or if they do have another job, it’s completely different from their work for the business
- their contract, statement of terms and conditions or offer letter (which can be described as an ‘employment contract’) uses terms like ‘employer’ and ‘employee’
In addition, if you’re an office holder, the employment status test is considered met. “Office holder” is not actually defined in the legislation, but by case law, and is taken to mean as acting as a director, senior manager or company secretary for the employing organisation. Or in HMRC’s view, “holding a permanent, substantive position which had an existence independent from the person who filled it, which went on and was filled in succession by successive holders”.
If HMRC do investigate, their starting point will therefore be the contract between the limited company and the client. They will look to see if it includes e.g. paid holiday, sick pay, pension scheme, redundancy and so on - in essence, working through the check list above. They will also look to see if the office holder criterion is met; and may consider whetheryour limited company looks like a business and runs like a business with premises (which could be based at home) and equipment, and markets itself as such. If it does, HMRC will consider it is likely to be a business.
Finally, they will consider what the courts and HMRC refer to as “mutuality of obligation”. This reflects the typical employer-employee relationship where the employer pays a worker a regular salary and expects them to undertake activities as directed. Employees are entitled to continue receiving remuneration if a particular project winds up, and to carry out tasks that may go beyond their core role. Genuine limited company contractors outside IR35 should neither expect nor receive such mutuality of obligation. A contractor’s limited company should be engaged on a contract for services basis, to perform a specific task for a specific project, and once the project is over the contractor moves on, or may be offered a new project by the client.
Please remember, HMRC don’t just look at the above – they review EVERYTHING in an effort to establish if you are really an employee or a director running, managing and controlling your own limited company. It doesn’t matter if you are working for the same client for one month or twenty years. It’s what you’re doing and your level of risk, responsibility, liability and control.
IR35: The key questions in detail
So that's the headlines. Now we'll get into the detail; if you've already decided it doesn't apply to you, you need read no further!
Control & supervision in the workplace
Even though your limited company has been contracted to provide a service, you will need to maintain control over your working conduct during that time - whereas an employee would be subject to their employer’s direction.
Principles to look out for in your contract are:
- Start and finish times appearing in the contract.
- Specific days the contractor should work in the contract.
- Allocated lunch time breaks and their duration in the contract.
- Any direct clauses which dictate that the client has supervision and control over the contractor.
These fundamentals should not feature in a business to business contract where a client employs your services as a limited company.
A good way to ensure you’re not caught by IR35 is if your contract allows you to supply a substitute or take on someone else to conduct your services. If the client has explicitly stated that you personally must conduct the contracted services then it may prove more difficult to argue against being caught by IR35.
As a contractor you should receive payment by invoicing your clients. As an employee you will receive payments from your client before you invoice, as a wage.
Level of involvement
HMRC will keep a watchful eye on how involved you are with a client’s corporate structure and your responsibilities within its operations. If you have the client’s staff reporting to you, or appear on telephone lists, then this won’t reflect well on your IR35 liability.
Even little things like obtaining a security pass to your client’s business, to avoid having to sign in every time you work, can contribute to being caught within IR35. Make sure there’s a clear separation between your services and the client’s business, and that you are not part and parcel of their operations.
If your client has had past rulings in which contractors previously engaged by them have been caught by IR35, you may need to be very careful in your contractual relationship. Make sure your contract is watertight, as the responsibility to pay tax correctly will reside with you..
Does the contract allow you to take on jobs from other clients, or does it stipulate that you must exclusively complete the task at hand over any other work? Are you bound by your contract to complete the work your client is giving you?
Whenever possible, you should have your own equipment available to conduct your services. However, IR35 reviews will take into consideration that you’re often required to use a client’s equipment for safety, security or practicality reasons. If there’s a sound business reason that mitigates your use then it’s usually accepted.
Liability & Insurance
If the work you’ve been contracted to complete is unsatisfactory then you are likely to be liable if you’re an independent contractor. In most scenarios you’re going to need your own private insurance as you
won’t be covered by company insurance as a contractor.
Right of dismissal
Do you have a fixed notice period? HMRC will argue that this is like an employee, therefore there should be provision in your contract for immediate termination should the client choose to do so.
If you receive any holiday pay, sick pay, pension contributions, training courses, join in with the Christmas dinners or the annual staff summer outing, HMRC will argue this is like an employee.
IR35 and the Public Sector
In 2012 the Treasury decided to lead by example on IR35 and tightened the regulations applying to contractors working off-Payroll in the Public Sector. Under the new rules, any contractor whose position is the most senior in a department is automatically placed on Payroll.
In addition, any contractor who has been working in a position for more than 6 months and earning in excess of £220 a day will be legally obligated to provide assurance (from a specialist) that they are not caught by IR35 and are paying the correct amount of tax. The responsibility to request assurance resides with the ‘client’ or ‘employer’ and although they’re legally obligated to do so, there is no consistency across the Public Sector of departments actually requesting this.
If you refuse, or fail to provide, accepted assurance that you are paying your tax correctly, your contract may be discontinued, or you may be placed on departmental payroll. Even once you’ve submitted assurance from a specialist, a client can legally make the decision to reject your provision unless the assurance is supplied from HMRC.
IR35 and the Private Sector
In the Autumn 2018 budget statement, the Chancellor announced that the changes introducted for people working in the public sector, outlined above, will arrive for private sector workers from April 2020. These include;
- As with public sector reform, the responsibility for operating the off-payroll rules will shift from individuals to the organisation
- To give businesses time to prepare, the change won’t be introduced until April 2020
- Small organisations will be exempt, to ‘ease the administrative burden’, and HMRC will support medium and larger organisations in implementing the change
So if I am caught by IR35, is there any point in working through a limited company?
If your contract and working practices look like you are inside IR35 you can still claim: traveling and accommodation expenses, 5% of your turnover, benefit from the VAT flat rate scheme, and receive interest on the funds held within your own company.
So yes, from a financial point of view it still could be worth it. Also, any other contract work you do could also be put through your existing company.