IR35 is a term you’ve probably heard of by now, especially if you’re a contracted worker. The full particulars of the legislation can be confusing, and it’s hard to understand whether you’re ‘inside’ or ‘outside’ IR35. Regardless, it affects the pay and tax of both private and public sector workers, so it’s worth wrapping your head around.
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What is IR35?
IR35 is the UK’s anti-avoidance tax legislation, it was designed to prevent ‘disguised employees’ from avoiding tax. A ‘disguised employee’ is an individual that has engaged with an organisation on the basis that they’re self-employed, or through an intermediary such as a limited company. However, without this intermediary, they’d be considered by HMRC as a permanent employee. Organisations that engage with contractors who are ‘disguised employees’ can save money as they don’t have to pay National Insurance contributions on the payroll of these staff.
The tax law came into force in April 2000 as part of the Finance Act and is officially known as the Intermediaries Legislation. Elements of the legislation have since been integrated into other regulations such as the Income Tax (Earnings and Pensions) Act 2003 and the Social Security Contributions (Intermediaries) Regulations 2000. The legislation is due to reform in April 2020 where we can expect to see some major changes.
What does it mean to be ‘inside or ‘outside’ IR35?
Each employee or contractor has an IR35 status which is either ‘inside’ or ‘outside’ the legislation. Read on as we explain IR35 status.
If you’re ‘inside IR35’, this means that HMRC considers you as an employee of your end client and you are therefore subject to the Pay As You Earn (PAYE) system. This means that you should be paying income tax and National Insurance contributions as an employee. If an employment IR35 test determines that you are ‘inside’ you need to ensure that these taxes are being paid, this could be through a ‘deemed payment’ at the end of the tax year, or managed by an intermediary such as a recruitment agency or umbrella company.
If you operate as a genuine business or self-employed worker, this means that you’re ‘outside IR35’. If you’re engaged in the public sector, it’s the end client who is responsible for determining your status. With this ‘outside’ status, you can pay yourself a salary, draw dividends and take full responsibility for your taxes.
So, how can you determine if you’re ‘inside’ or ‘outside’? Ultimately, the contractor has to prove that there is no ‘employment relationship’ with the end client to be classed as ‘outside’. There are three main factors to consider and these make up the IR35 rules:
Mutuality of obligation
If you consider yourself as a self-employed contractor or a freelancer, work generally comes to you in the form of a temporary project. This means that there are no legal obligations for a freelancer to continue working with that client once the project, and contract, is terminated. Also, you’re often paid on a project-by-project basis. In the same train of thought, the end client does not have to offer the contracted worker any further employment or involvement in a project once the contract has ended. If this doesn’t sound like your situation, you might be ‘inside IR35’. Under the same issue, if your end client presents you with a contract that does not allow you to take on a project with another organisation when you’re in a contract with them, this also means that you’re ‘inside’.
Substitution
To be considered as ‘outside IR35’, it must be clear that the client is engaging with a contractor because of their services and not for their employment. One way to demonstrate this is with the rule of substitution. If a contract specifies that one individual must complete the project from start to finish, this can mean that the contractor is ‘inside’.
Supervision, direction & control
If you are a freelance worker or self-employed contractor, you should have full supervision, direction, and control over how the project will be completed. If an investigation finds that the end client had a high level of input into working patterns, for example, this could see your status become ‘inside IR35’.
Other considerations to make might be the assets that you have as a business owner. The possession of a website, office, and employees all indicate that a contract worker is in fact of their own entity. Similarly, if you own your equipment when completing the project rather than using any equipment that a client provides, this indicates that you are ‘outside IR35’.
How is IR35 changing in April 2020?
In a proposed IR35 reform, due April 2020, HMRC plans to change the legislation for private companies in a similar way to the changes that were implemented in the public sector in 2017. The changes will mean that medium and large companies who engage contractors will be given responsibility for setting the tax and IR35 status of these independent workers. Or, if there is a different fee-paying party in the situation (such as a recruiter or umbrella company), the tax liability will be transferred to them.
When the change was implemented in 2017, thousands of contractors were unfortunately given the wrong status, with many clients placing them ‘inside IR35’. It is thought that this is because the legislation is difficult to understand and organisations wanted to avoid any potential penalties. With the 2020 reform, HMRC has announced that it will be a requirement for all end clients to provide the reasoning behind the status that they give a contractor. The decision will be transparent to contractors and they will have 45 days to appeal the status if they think it is incorrect.
Another major change in the legislation is the removal of “small” private sector companies who will be excluded from the 2020 reform and will not be given liability.
Who is affected by IR35?
IR35 can affect more members of the supply chain than you might think, and with the proposed changes, it’s worth noting who will be managing the tax liability.
Self-employed and contract workers
First up are self-employed and contract workers. As we’ve established, this type of worker generally works on a project-by-project basis, they should be able to prove that they’re a fully functioning business without any reliance on their end-client. You can find out more about this with an in-depth look at “How does IR35 affect contractors?” article.
At one time, these workers would be in charge of determining their tax status. But, with the existing reform in the public sector and the proposed reform in the private sector, it will now be down to the end client or intermediary to determine the tax status. It’s important that this group get to know the ins and outs of IR35 in the public sector and IR35 in the private sector to determine their status with their end clients and learn their rights when it comes to an appeal of an incorrect decision.
Recruiters
Often contracted workers are placed by recruitment agencies. These agencies must also pay attention to IR35 and the proposed changes if they handle the payments of the contractors. Their liability means that any errors in payroll or rule-breaking could result in hefty fines for these agencies.
Medium and large companies
As business owners, many medium and large companies may now find themselves responsible for determining a contractor’s IR35 status. This means that they must carefully review the contract and see that there is no employment relationship and that the contract is clearly ‘outside IR35’. A wrongful decision on this status could mean future penalties and tax deductions from the contractor.
How can you make sure you comply with IR35?
Bearing the threat of penalties in mind, all contractors, agencies and medium to large-sized companies want to ensure that they’re complying with IR35. As a contractor, how can you ensure you’re following the rules?
Take a good look over your contract
Reviewing your contract with your end client is the first step to complying with IR35. As we mentioned before when discussing the IR35 rules, you need to make sure that your contract does not: state you’re under obligation to work for the company once your contract ends; state that you’re the only individual who can complete the project; outline any set working patterns or determine how the work should be completed.
Carry out an HMRC IR35 assessment
HMRC has designed a CEST assessment, this stands for Check your Employment Status for Tax. However, the tool has been criticized so it’s worth doing this as well as reviewing your contract alongside the IR35 rules.
Although you can assess your situation and ensure you comply moving forwards, an IR35 investigation might determine that you owe income tax, NICs, interest, and a penalty if you haven’t been complying in the past. You can find out how your salary would be affected by using the IR35 calculator. You might think that IR35 inquiries are only carried out into those who are considered to be operating ‘inside IR35’, but investigations are also launched into those who are ‘outside IR35’. This is why it’s important to be clued up on the legislation and what it means for you.
Go through an umbrella company
If you’re a contractor who is struggling to get your head around IR35 or would rather leave the ins and outs of the legislation to someone else, it might be worth using an umbrella company. These companies manage your National Insurance contributions and taxes so that you don’t have to do any tedious paperwork. Umbrella companies also offer you better take-home pay, insurance and automatic compliance to HMRC and IR35. Use our free comparison service and compare umbrella companies with the useful form on this page.
Protect yourself with IR35 insurance
Keep yourself protected with IR35 insurance. Investigations into IR35 can be lengthy and confusing, especially if you’re not fully clued up on the tax rules. However, with IR35 insurance, you can get financial security in the case of paying your tax liabilities and you’re often presented with representation to help fight your case if it went to tribunal. It’s certainly something worth looking into. As we can see, there is a lot to take in when it comes to IR35 and the proposed reform that’s due to happen on April 2020. Taking steps to ensure that you’re complying or working closely with an umbrella company is key to ensure that you don’t face any hefty fines or penalties.