For those who may not be familiar with IR35 (where have you been?) – perhaps those of you who are new to, or who work on the periphery of the contractor market, for example – we thought we would provide a simple introduction and overview of the key points of this UK centric legislation, so that you are not completely in the dark. It should however be noted that this is certainly an area that requires professional advice and if you have concerns or queries in this area, you should consider engaging an experienced IR35 service provider.
What is IR35?
IR35 became law in 2000 via the Finance Act and is also known as the off-payroll working rules.
It is a UK tax legislation designed to close a loophole in the tax system whereby workers could pay less tax by setting up a limited company (or partnership), than they would if they were employed. IR35 is the common term for Chapter 8 Part 2 of the Income Tax (Earnings and Pensions) Act 2003 (ITEPA), also known as the Intermediaries Legislation. So, with all these different names, why is it referred to as IR35? Well, IR35 was the name of the press release from the then Inland Revenue (now HMRC) which announced the legislation introduced in 2000 and has become the common reference for the legislation.
Some of the criteria used to determine whether someone is ‘inside’ (i.e. employed for tax purposes) or ‘outside’ IR35 (self-employed for tax purposes) is common sense; if you act like and are treated like an employee you should be taxed as one. However, there are a lot of grey areas in the legislation and some points which may seem relatively insignificant can have a major impact.
On 6 April 2021, the ‘new’ off-payroll working rules were introduced. This meant that the IR35 determination process changed for those engaged with a medium or large client in the private sector. These changes have already been in place for the public sector since 2017.
Simply put, the off-payroll working or IR35 rules are designed to stop contractors working as ‘disguised employees’, by taxing them at a rate similar to normal employment, and it affects all contractors who do not meet HMRC’s definition of self-employed. The cynics among you will also appreciate that such an approach may simultaneously swell the inward flow of funds to the Treasury.
People commonly reference ‘Inside IR35’ and ‘Outside IR35’ – what do they mean?
Inside IR35 – brief overview
If you are determined to be ‘inside IR35’ this means you do not meet HMRC’s definition of self-employed. You are considered an employee of the end client and are therefore subject to PAYE, requiring you to ensure that you are paying the appropriate taxes.
IR35 employment status indicators
There are three main factors (there are others) taken into consideration when assessing a contractor’s working arrangement to determine whether they are ‘inside IR35’ or ‘outside IR35’:
- Right of Substitution
Substitution is the ability of a contractor providing a contracted service to supply a replacement contractor to carry out the service under the contract. For example, if Paul was ill, then Peter could be provided to continue the work in Paul’s absence.
2. Mutuality of Obligations (MOO)
MOO means that for an employment relationship to exist, there must be an obligation on a work-provider to provide work and an obligation on the individual to carry out the work. We all have a MOO here at Access Financial – we are expected to turn up to work Monday – Friday each week, on time, work our contracted hours and perform to the best of our ability for our employer. Access Financial, on their part, provide us (as the employee) with the tools (office, desk, phone, PC etc.) to enable us to carry out our work.
3. Control
Control looks at whether a worker is truly independent when working under a contract between it and the end-client. The more factors showing independence of work behaviour, choice of how and when to perform the work etc., indicate a scenario where IR35 does not apply.
For more information, you can read HMRC’s guide to determining employment status here.
Outside IR35 – brief overview
If you are determined to be ‘outside IR35’ this means you meet HMRC’s definition of self-employed. You are considered a genuine business and can operate and be engaged with as an independent contractor. You would be paid gross for any work completed.
What is HMRC’s definition of self-employed?
As per gov.uk, if someone is self-employed “most of the following are true”:
- they put in bids or give quotes to get work
- they’re not under direct supervision when working
- they submit invoices for the work they’ve done
- they’re responsible for paying their own National Insurance and tax
- they do not get holiday or sick pay when they’re not working
- they operate under a contract (sometimes known as a ‘contract for services’ or ‘consultancy agreement’) that uses terms like ‘self-employed’, ‘consultant’ or an ‘independent contractor’.
HMRC states that they will take an overall view of a contractor’s position to determine whether they will be deemed ’employed’ under the rules, therefore it is extremely important that any contracts reflect the actual working practices.
Who determines whether the engagement is ‘inside’ or ‘outside’ of IR35?
Currently, there are two IR35 decision-making regimes.
Limited company contractors (‘Personal Service Companies’ or ‘PSCs’) engaged in the public sector or by a medium or large-sized company in the private sector, have their IR35 status determined by the engager (‘the end-client.’)
This is because of the ‘off-payroll working reforms’ and is often referred to as being under Chapter 10, specifically Part 2 Chapter 10 Income Tax (Earnings and Pensions) Act 2003.
But the legislation has two key exemptions – PSCs engaged by ‘small companies’ as defined by the Companies Act, and PSCs’ engagers who are based wholly overseas. PSCs whose clients fall into either of these two camps are responsible for their own IR35 decision-making. This is ‘old’ IR35, found under Chapter 8 of the same legislation.
In both cases, the (PSC) decision-maker must demonstrate that they have taken ‘reasonable care,’ or they risk HMRC conferring upon them the tax and NIC liability, and even seeking to apply a penalty on any liability due.
What view do HMRC take?
Should an enquiry be initiated, HMRC will look at the contract a contractor/their PSC has with their agency/end client. Therefore, the nature of the contract is key when determining the IR35 status. Some contracts may contain negative clauses from an IR35 perspective, so it’s important to have it reviewed as early as possible by a competent IR35 advisor(s). Many service providers now undertake IR35 contract reviews as a paid for service.
HMRC will also take a close look at the actual working relationship between the contractor and their client, commonly referred to as the ‘actual working practices’. Even if the engagement contract is IR35 compliant but HMRC determine that, in reality, the contractor has been treated like an employee, HMRC may consider the written contract to be worthless and nothing more than window-dressing. It is therefore vital that the contract and working practices mirror each other – what is written on paper, should be carried out in practice too.
In conclusion, we hope that what is intended to be an introduction, for the layperson, to the considerable depths of IR35 has been of use and if we can assist further with any IR35, or any contract management, international payroll and compliance management queries, please do not hesitate to contact us!