IR35 is a piece of tax legislation that was brought in with the Finance Act in 2000 by the government. It is designed to prevent tax avoidance by personal service companies, and aims to tax ‘disguised employees’ at a similar rate to those in full-time employment.
IR35 aims to catch out workers who are avoiding paying tax and National Insurance Contributions (NICs) by operating as limited companies, when they should be full-time employees.
For example, if you previously worked as an employee for a company, and show up the next week as a limited company working through an agency, you won’t pay the same in tax and National Insurance.
If you provide the same service to the same client on more or less the same contractual basis, the chances are you’re trading within IR35. HMRC will use the ‘hypothetical contract’ between yourself and your client to determine your employment status.
If HMRC decides your contract puts you within IR35, you’ll have to pay tax and NICs, rather than taking your director’s salary and dividends (which is much more tax efficient).
For those within IR35, who are viewed as trading as a personal service company solely for tax avoidance reasons, they are described as a ‘disguised employee’. If you’re a disguised employee you may also be referred to as being ‘inside’ IR35. If you’re not a disguised employee you are ‘outside’ IR35.
Are you a contractor or disguised employee?
Unfortunately there is no definitive rule to say whether someone is inside or outside IR35, instead the situation as a whole should be considered. Contractors should regularly look at their risk to the legislation and assess whether or not they are likely to be caught by IR35.
Although fairly unlikely, HMRC can randomly investigate your business to assess your IR35 status, so it’s important that you can demonstrate that you have assessed your risk regularly and can demonstrate that it’s unlikely you’re inside IR35.
Determining your status
Determining your status is based on the ‘hypothetical contract’ between you and the client. The circumstances under which you work are outlined in the hypothetical contract. HMRC makes a decision based on these circumstances as to whether the individual is a genuine contractor or a disguised employee.
There are a number of case law judgements that HMRC use to determine whether an individual falls within IR35. However, there are three key case laws used which are widely recognised to be the defining factors of determining if a contractor is inside or outside IR35:
Control focuses on how the work is undertaken and who has control of it. The main points HMRC will consider are the working hours and the location where work is carried out. If you’re a contractor who’s allowed to complete the work at any time and in any location, it looks like you’re acting as a genuine contractor.
However, if you’re given a specific time frame to complete work in (such as 9-5, Monday to Friday) and you must travel to and from the same location every day to complete it on the client’s premises, then it’s likely you’ll fall under the definition of a disguised employee. This can get complicated when work must be carried out on a certain premises, such as with those contractors working on building sites, so it’s worth speaking with a professional if you’re unsure.
2. Mutuality of obligation
Mutuality of obligation is concerned with the duties the client and contractor are obliged to fulfill. For example, an employed person is expected to give notice before they leave a job, and work for that amount of time before leaving. However, a contractor has the right to walk away from work with a short notice of leaving. There may not even be a required notice period for some contractors.
A contractor is also likely to complete a contract and not expect any further work to be given to them, as the client is not obliged to do so. On the other hand, a full-time employee would expect to be given more work by their employer after they’ve completed a project.
3. Personal service (and substitution)
The personal service clause is concerned with the roles of client and contractor in terms of who is able to delegate work to others.
As a contractor, if you’re unable to complete the work you will be able to delegate it to whoever you deem fit. However, full-time employees are not expected to delegate work, as it is the employer who is expected to delegate work.
If your client allows you unlimited delegation, the chances are you don’t fall within IR35. Likewise, if your client allows you complete control over choosing your own substitute should you be unable to complete a project, you are unlikely to be trading as a disguised employee.
These are believed to be some of the most important factors to consider. Aside from these three, here are the some of the other case laws that are used by HMRC to determine an individual’s status:
Provision of equipment
Basis of payment
Part and parcel
Exclusive services and length of engagement
Right of dismissal
Intention of the two parties
Working inside IR35
If you are deemed to be inside IR35 then there are a number of options available to you to engage with your client:
You can use an umbrella company. Umbrella companies can be useful if you envisage having a very short contract, as there will be less hassle. Umbrella companies will manage your invoicing to the client and pay you through PAYE. However umbrella companies can be less tax efficient.
Alternatively, you can trade as a limited company but take the profits of the contract as a salary. This is more tax efficient than an umbrella company because you can still benefit from the VAT flat rate scheme and a flat 5% expense rate along with other expenses.
Our advisors are able to give you the best advice about what to do next, and can help you find the most tax-efficient way of trading within IR35. If you’re unsure about whether you’re inside IR35, or if you are inside IR35 and want to know more about your options, just give us a call.
What are the changes to IR35 from 6th April 2021?
In the private sector prior to 6th April 2021 the contractor has always been responsible for assessing whether or not their own company is inside or outside of IR35. From 6th April 2021 the responsibility for this assessment is shifting to the engager if they are a medium or large company.
Unfortunately many medium and large companies have seen this change as a big risk and have made blanket determinations on the status of their contractors and deemed them all to be inside IR35. Many of these companies have started to insist that their contractors either work through umbrella companies or as an employee rather than completing individual assessments.
If your engager is a small company then the responsibility still falls on your shoulders rather than your engagers and so nothing is likely to change for your circumstances.
These changes were set to go live on 6th April 2020 but were delayed due to the COVID-19 pandemic.
Frequently asked questions
What is a personal service company?
Typically, a personal service company is a limited company that has a sole director/shareholder. A personal service company provides professional services to a client which require the skill or experience of a contractor.
How do I check if I’m inside or outside IR35?
It’s almost impossible to be 100% sure that you are working inside or outside of IR35 as it is a grey area which is not well defined by HMRC and the goalposts change all the time along with case law. You can however assess your risk to IR35 by looking at your arrangement (deemed contract) with your engager and evaluating if it’s likely you would be deemed a ‘disguised employee’ or not.
HMRC also have a tool (CEST) you can use to help determine your status which can be found here: https://www.gov.uk/guidance/check-employment-status-for-tax Although the tool can never be 100% accurate, HMRC has said it will stand by the result as long as you answer the questions honestly and accurately and assess your risk on a regular basis.
How can I avoid IR35?
If you’re worried about falling within IR35, there are a few ways you can help yourself steer clear.
First and foremost, behave like a business. Create a contract for each project and include on it terms of Control, Mutuality of Obligation and Personal Service. This will be affected by how you act as a contractor on a day-to-day basis.
Make sure your project has an end date, and that the contract is valid for the length of time you will be working for the client. Including a short-term notice period will also work in your favour if you are ever investigated by HMRC.
Failing to market your business may work against you if you become the subject of an IR35 investigation. Keep the eyes off you by creating a business logo, a name (not your own) and a website that markets your services.
Does it matter how long I have been working with a client?
The length of a contract with a client alone won’t mean you automatically fall under IR35. However, the longer you do work with a client for, the easier it will be for HMRC to assume you are working as a disguised employee. It will also become harder to demonstrate your independence from the business in the event of an investigation.
Should I avoid working with a client if I have worked with them before?
If you were previously employed by a client and are now working for them as a contractor, you are at higher risk of being caught by IR35. If you previously worked with the client when you were a contractor, there’s a lower risk of being caught inside IR35. However, you should take steps to make it clear that you are treated as a contractor rather than an employee.
What if one of my contracts is inside IR35 but others are not?
Each contract is treated individually. That means, if you have a number of contracts with different clients, they will have to be reviewed separately to decide if each one falls under IR35.
The following questions are relevant to you if your contract falls inside IR35...
Do I still need my limited company if I use an umbrella company?
If your only contract is through an umbrella company and you are no longer using your limited company then you may want to close it down. If you think you will have contracts in the near future which are outside of IR35 then it would likely be better to keep the company open instead.
Can I still take a directors salary from my company if I am employed under IR35 elsewhere
The purpose of taking a small director’s salary is to utilise your personal tax free allowance. If you are employed elsewhere outside of your company then it’s not going to be beneficial to draw a salary from the company. It is likely going to be more tax efficient to take income in the form of dividends only from the company.
Can I still claim expenses in my limited company?
When calculating your ‘deemed salary’ through your company’s payroll a 5% allowance is given to cover expenses such as rent, accountancy fees, stationery etc. Every day expenses like travel and hotels are not claimable but contractors can still claim additional expenses that they would have been able to claim as an employee. These expenses are however difficult to claim and must have been incurred ‘wholly and exclusively’ for the employment.
Will IR35 affect my limited company pension contributions?
You can still direct a portion of your gross fees directly into a pension scheme before IR35 taxes are applied. This can be a significant relief for contractors who are working inside IR35.
What happens with my company, i.e. does it need to close or be non-trading
If your only contract through your company has been deemed to be inside IR35 and you are not processing your ‘deemed salary’ through your company’s payroll then you can either keep the company open in a ‘non-trading’ state or close it down. Keeping the company open may be useful if you think you will use it again in the near future for other contracts otherwise closing it down is likely the better option.
Are there any changes to the services provided by The Accountancy Partnership?
This depends on whether you can and want to still operate through your limited company inside IR35. If you choose this way of working then the income from your contract will be processed through your company’s payroll. The Accountancy Partnership can manage this for you, simply get in touch for a quotation.
What if I have one contract under IR35 and other streams of income are outside IR35?
Each contract is assessed individually. Any contract inside IR35 should be paid through payroll, either via an umbrella company, your own company or directly with the engager/agent. Other contracts you have which you consider outside IR35 can be treated normally through your company, i.e. regular expenses claimed and profits taken as dividends.
What if I do not agree with the end clients determination in regards to my contract being within IR35 or not?
Your end client or ‘engager’ may have blanket determined their contractors, insisting work is carried out through employment or umbrella companies. These blanket determinations can often be incorrect and each contract should ideally be evaluated on its own individual circumstances. If you believe the incorrect decision has been made then it is recommended you appeal to your engager and demonstrate why you believe the contact should not be deemed inside IR35.
Do you have a calculation I can use to work out my inside IR35 rate?
HMRC provide a free calculator on an Excel spreadsheet at the following link: https://www.gov.uk/guidance/hmrc-tools-and-calculators#ir35-working-through-an-intermediary
If you have any further questions regarding IR35 simply phone 020 3355 4047 and of our friendly advisors will be happy to help.