The IR35 tax law has existed since 2000 and applies to contractors who do not meet HMRC’s criteria for being self-employed.
IR35 is an often-overlooked area in business accounting and finance compliance, but HMRC is extending their reach over who they can catch with IR35. It’s worth paying attention to IR35, regardless of whether you’re a contractor or company that contracts services from the self-employed.
IR35 sets out the rules for working off-payroll and defines when someone is a genuine contractor or is working as a ‘disguised employee’, enjoying the tax benefits of working as a limited company.
Contractors who work through their own limited company are more tax-efficient than standard employees, for both the contractor and the employer. Employers can avoid paying their National Insurance contributions, pension contributions, and aren’t obliged to give employee benefits whereas contractors are more flexible with their tax returns.
This tax-efficient set-up is prone to manipulation and tax avoidance when someone is working as if they’re self-employed when in reality, they’re an employee working off-payroll.
IR35 acts as a test that attempts to work out whether a contractual relationship is genuine self-employment or whether it amounts to disguised employment.
- If the contract operates ‘inside IR35’, tax is calculated and paid as if there is an employment relationship. The employee will then be treated as such for tax purposes.
- If the contract operators ‘outside IR35’, then the relationship constitutes self-employment.
The IR35 rules that define whether a contract is ‘inside’ or ‘outside’ IR35 are notoriously complex and have been host to some high-profile cases, including in 2019, when the TV presenters Kaye Adams and Lorraine Kelly challenged HMRC, who argued that their employment relationships were inside IR35. They were successful in their challenge.
Eamon Holmes and Christa Ackroyd however failed in their appeals against IR35, largely because they were found to be ‘under control’ of the employers and therefore counted as employees. Conversely, Kaye Adams and Lorraine Kelly were found to be in control of their own work; they wrote their own scripts, held no conflict of interest agreements or exclusivity with their producers, etc, and were thus found to be self-employed. Employer control is just one criteria HMRC uses to determine whether a contractor is inside or outside of IR35.
Supervision, direction and control: This is the main IR35 test that differentiated the aforementioned celebrity cases. It describes the control the suggested employer has over your work, e.g. whether they dictate your working hours, provide you with services you need to do your work and whether you’re autonomous in your working decisions. Another aspect of this is equipment - is the contractor self-sufficient with their own equipment and tools for the job, or are they relying on the other party to provide?
Substitution: Can your work be substituted for someone else, or does it need to be you as an individual that has to complete the work, which suggests an employment relationship. If you can be substituted for another contractor, the relationship is likely to fall outside of IR35.
Mutuality of Obligation: Does the employer have some form of obligation to provide work, and if they offer it, are you obligated to accept it? This would suggest an employment relationship and thus, the contract would fall inside of IR35.
Use this government tool, the CEST tool, to work out whether you’re operating inside or outside of HRMC on any given contract. The tool is not entirely accurate due to the complexity of IR35. As you can see, the above criteria tend to be highly subjective, which is why HMRC struggles to uphold IR35 rules in certain cases. However, as HMRC becomes more data-equipped with the information they need to route out lower-level disguised employees, they’re expected to intervene in more IR35 cases in the coming years.
The self-employed IR35 rules changed in April 2021. Prior to April 2021, public sector companies only would carry the responsibility for declaring a contractor’s employment status to HMRC, whereas the contractor would carry the responsibility if they worked in the private sector.
After April 2021, medium and large businesses in the private sector now take on the responsibility for declaring a contractor’s IR35 status. Contractors should be given a Status Determination Statement that declares their employment status, and are able to object to that if they so desire.
- Having an annual turnover under £10.2 million
- A balance sheet total of no more than £5.1 million
- Fewer than 50 employees
These changes mainly apply to larger private sector businesses - we can see that the ‘small business exemption’ is quite generous in how it defines small businesses. Any business that finds their contracts lie under these new obligations will have to report the contractor’s employment status and start paying tax as if they are an employee. Another point worth noting is that, if the parent of a group of subsidiaries or small companies falls under the criteria as a medium or large business, then their subsidiaries will have to implement the changes.
The self-employed should always be aware of their contracts and whether or not IR35 applies to them. Whilst it might not be their responsibility to report their contractual relationship to HMRC in the case of public sector workers or those contracted to medium or large companies, it’s still vital for all self-employed limited company owners to have a handle on IR35.
For any private sector companies to which the small company exemption does not apply, it is now their responsibility to determine IR35 status. If the client is a small business, then it’s still the contractor’s responsibility to declare their IR35 status.
Freelancers that work on-site, use equipment provided by their client, have regular, formal agreements regarding workloads, commitments and hours, or otherwise engage in mutual obligations with their clients are likely classifiable as employees contracted inside of IR35.
The self-employed should get into the habit of reviewing their freelance engagements regularly and recording their due diligence to prove that they’re aware of IR35 and are taking the necessary steps to work out their status for each contract.
Whilst many IR35 cases are high-profile and concern high net-worth individuals, this is certainly not the rule. HMRC has access to more data than ever before - it’s always worthwhile keeping on the right side of tax compliance.
IR35 is an often-overlooked area of employment and tax compliance. It applies to a huge variety of self-employed individuals in the UK that operate through their own limited companies.
Limited company status is not sufficient to define oneself as self-employed if the relationship bears all the hallmarks of standard employment - that is where IR35 comes into play. For business accounting post-2021, companies in the private sector need to be aware of when it is their responsibility to determine IR35.
IR35 tests a range of characteristics of the employment relationship to determine the status of the worker. Some of these are obvious, such as working on-site with defined hours, mutual obligations and ongoing responsibilities - such will nearly always count as employment. Other employment situations are more complex.
In any case, due diligence and awareness are critical to anyone who is unsure of their employment status. It’s worth scrutinising every working relationship for compliance with IR35.
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