What is IR35?

What is IR35?

IR35, also known as the Off-Payroll Working Rules, is a tax legislation introduced to combat tax avoidance by workers who supply their services through an intermediary, typically a limited company, but would otherwise be considered employees if directly engaged by the client. It targets so-called ‘disguised employment’, where contractors may operate as a business entity to benefit from tax advantages while maintaining an employee-like relationship with their clients.

If you’re a contractor operating through a limited company, understanding IR35 is crucial to ensure you stay compliant with HMRC and avoid penalties.

IR35: Background

The IR35 legislation dates back to March 1999, when the Inland Revenue (now HMRC) announced measures to tackle disguised employment. Since its introduction in 2000, the IR35 rules have undergone several reforms aimed at improving their application and clarity.

Timeline of Key Reforms:

• 2017 IR35 Reforms: Shifted the responsibility for determining IR35 status from contractors to public sector clients.
• 2021 IR35 Reforms: Extended the changes to the private sector, placing the responsibility on medium and large businesses to determine a contractor’s IR35 status.
• 2022 Mini-Budget: Proposed repealing the 2017 and 2021 reforms. However, the repeal was reversed in October 2022, meaning the IR35 rules remain in force.

What Does IR35 Mean for Contractors?

As a contractor, IR35 impacts whether you’re classified as an employee or a self-employed contractor. Your IR35 status determines how you’re taxed and whether you need to pay National Insurance Contributions (NICs) like a regular employee.

Inside IR35:

If your contract is deemed to fall inside IR35, you will be treated as an employee for tax purposes. This means:

• You will pay income tax and NICs through PAYE.
• Your client or agency will deduct these from your payments.
• You will lose the ability to take advantage of the tax efficiencies offered by operating through a limited company.

Outside IR35:

If your contract falls outside IR35, you are classified as a genuine self-employed contractor, and:

• You can benefit from the tax advantages of running a limited company, such as drawing income through dividends.
• You are responsible for ensuring your NICs and tax payments** are made correctly.

IR35 Criteria

There are several key factors used to determine whether a contract falls inside or outside IR35:

1. Control: Does the client have direct control over your work, such as specifying when, where, and how you complete tasks? The more control your client has, the more likely your contract is inside IR35.
2. Substitution: Can you send a substitute to do the work if necessary? If the contract allows for substitution, it’s more likely to be outside IR35.
3. Mutuality of Obligation: Is there an obligation for the client to provide continuous work and for you to accept it? A lack of mutuality of obligation can indicate that the contract is outside IR35.
   

How Does IR35 Affect Small, Medium, and Large Businesses?

The responsibility for determining IR35 status varies depending on the size of the client’s business. According to the Companies Act 2006, businesses are classified as follows:

• Small Business: A company that meets two or more of these conditions:
  • Turnover of less than £10.2 million
  • Balance sheet total of less than £5.1 million
  • Fewer than 50 employees
• Medium or Large Business: Any business that exceeds the limits set for small businesses.

For small businesses, the contractor remains responsible for determining their IR35 status. For medium and large businesses, the responsibility shifts to the end client or agency.

Impact of IR35 on Contractors

IR35 has significant implications for contractors in both the public and private sectors. If your contract falls inside IR35, your income is subject to PAYE tax, resulting in higher tax and National Insurance contributions, reducing your take-home pay.

HMRC estimates that IR35 non-compliance results in an annual loss of £1.2 billion for the UK Treasury, and the 2021 reforms are expected to bring an additional £1.3 billion by 2023.

HMRC’s CEST Tool

To help businesses and contractors determine their IR35 status, HMRC developed the Check Employment Status for Tax (CEST) tool. This digital tool is designed to assess whether a contract falls inside or outside IR35.

However, the tool has been met with criticism due to its inconsistent and sometimes inconclusive results, with 15% of users reporting uncertainty regarding their employment tax status.

The CEST tool considers several factors, including:

• The worker’s responsibilities
• Who decides what work needs doing
• How the work is paid for and delivered
• Whether the engagement includes benefits or expense reimbursements

While using the CEST tool can provide guidance, contractors should seek professional advice for accurate assessments.

Determining Your IR35 Status

Understanding whether you fall inside or outside IR35 requires a thorough review of your contracts and working practices. Here are a few steps to take:

1. Review Your Contract: Make sure your contract accurately reflects the working relationship and meets the criteria for outside IR35.
2. Conduct a Self-Audit: Regularly review your working practices to ensure they align with IR35 compliance.
3. Seek Professional Advice: Engaging with an IR35 specialist can help ensure your contracts are structured correctly and you’re compliant with the rules.
   

Consequences of IR35 Non-Compliance

Failing to comply with IR35 legislation can lead to substantial financial penalties. If HMRC investigates your contracts and finds that they fall inside IR35, you may face a large tax bill, including backdated NICs and income tax. Additionally, you may also incur interest and penalties.

How eAccounts Can Help

At eAccounts, we specialise in helping contractors, freelancers, and consultants navigate the complexities of IR35. Our expert IR35 accountants can assist you with:

• Reviewing your contracts to determine whether they fall inside or outside IR35.
• Ensuring your working practices align with your contracts.
• Offering tax planning advice to maximise your take-home pay if you fall outside IR35.

Our partnership with Qdos, a leading specialist in IR35 contract reviews, allows us to provide thorough IR35 assessments to ensure your compliance with HMRC’s regulations.

FAQs

1. What is IR35?

IR35 is a UK tax legislation designed to prevent contractors from reducing tax liabilities by working through an intermediary, such as a limited company, while performing services similar to an employee.

2. Who is responsible for determining IR35 status?

For small businesses, the contractor is responsible for determining their IR35 status. For medium and large businesses, the end client or agency is responsible.

3. What are the penalties for non-compliance with IR35?

If HMRC determines that a contractor is inside IR35 but hasn’t complied with the rules, they may be required to pay backdated NICs, income tax, interest, and penalties.

4. How can I check if my contract is inside or outside IR35?

You can use HMRC’s CEST tool to assess your contract’s status or seek professional advice to ensure accuracy.

5. What are the key factors in determining IR35 status?

Key factors include control, right of substitution, and mutuality of obligation.

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