What is IR35?
In short, IR35 legislation was introduced with the aim of eliminating the avoidance amongst contractors of PAYE tax and National Insurance contributions via the use of intermediary companies (such as personal service companies made up of freelancers and contractors) and partnerships. However, so broad is its scope and so open are its terms of reference that many contractors end up getting caught out by it – unfairly according to them – and having to pay more tax and penalties on their income. This guide will look at IR35 in detail and try to clear up some of the complications and problems associated with IR35. Put simply, you need to establish what makes you different from a typical employee working in the same organisation.
What Exactly Is IR35 Legislation?
As was mentioned briefly above, the IR35 legislation, introduced in April 2000, was added to the statute books with the sole aim of determining whether contractors working in a limited company could for any reason be deemed to be employees of a particular client rather than freelancers or contractors. This was done because the government and HMRC believed that there were circumstances occurring whereby contractors were providing their professional services to a client by means of either a partnership or limited company and in doing so were purposely avoiding paying the normal PAYE tax and NIC’s. Instead they would be saving themselves (and the company they were working for) a great deal of money by opting for the NIC’s, dividends and corporate tax of partnerships or limited companies that would be significantly lower. IR35 legislation was HMRC’s response, designed to determine those circumstances in which an individual worker (such as a freelancer or contractor) was working as a contractor for tax purposes in which he or she would otherwise be regarded as a regular employee of their client and for national insurance purposes would otherwise be regarded as a regular employee of their client.
An extreme and obvious example of this might be in a firm where an employee quits their job (or is given notice) at the end of the week and then returns to work the following Monday as a contractor working for their own limited company, doing exactly the same kind of work, for the same sort of hours, working for the same boss and being involved in the company just as much as before. This, of course, is a very obvious example and one that would immediately be flagged by IR35 legislation. Where the problems start is when the line is not so clear-cut. For many contractors there can be significant tax advantages to working via a limited company or partnership, but nowadays those tax advantages are reliant on the contractor’s individual contracts falling outside of IR35. You would assume it should be quite easy to draw some clear lines between working as a contractor and an employee but this is HMRC and nothing is ever easy. There is no definitive rule to IR35 and that’s why it is important to know what HMRC will be looking for and how they will be drawing their conclusions.
So, when sitting down and examining your own contracting status, don’t assume it is going to be as clear cut as you might think. Don’t just say to yourself ‘I’ve got my own limited company and I don’t have any permanent work so I’m safe from IR35’ as you might end up in trouble. HMRC have become more and more determined and ruthless in their pursuit of tax avoidance of contractors (if you want proof look at all the legislation that has followed IR35) and are seemingly obsessed with moving as many contractors as possible onto payroll. That’s why you need to be aware of the many questions to ask yourself in order to work out what your true contracting status (in their eyes at least) will be. And those questions need to cover everything, because HMRC will, if needs be, thoroughly review every aspect of your contracting life in order to ascertain your status with regards to IR35.
So, the chief things that they will be looking out for in order to work out your status are whether you, as a freelancer or contractor (who is running your own partnership or limited company) are maintaining and experiencing the same levels of risk, responsibility, control and liability as other directors of limited companies do who are working in a similar role. These four areas will become like a mantra to you as you work through your IR35 status as it is specifically these four areas, over and above everything else that will make clear to HMRC whether you are contracting legitimately or whether you are engaged as a false employee.
And of course there are a number of considerations to consider that tie into these four areas and to check whether they apply to your own dealings via your contracting company:
Control – Do You Have It?
Your very first question then should be to ask yourself how much control you have over your own provision of services. Again, this will never be completely clear-cut but it is essential to be able to show HMRC that your work is provided to your clients with you always maintaining an appropriate level of control as you do it. In other words, you would always be in charge of what services you perform, where you perform them, when you perform them and how you perform them.
A basic example of this might be a web designer who has been hired to design a specific page of content for a company’s site. If that web designer is told to come in, sit down and design that page on a Thursday afternoon then they are being told what to do and they therefore have little control over the services being provided – they are something more akin to a standard employee. However, if that same web designer is hired to design that page of content for the site and they request that it is done on Thursday afternoon but the contractor then tells them he can’t do Thursday but is available Wednesday or Friday; then he or she has maintained (and can show) a level of control over their own provision of services that is correct and appropriate for a freelancer or contractor but which would not be appropriate for an employee of that company. It is, in this instance, easy to differentiate between the two scenarios. It is clear who is in control and who is managing the provision of services. As a contractor you will of course need to hand some control to the client but it should not be about the specific provision of the service, more about the service that they require. Your control relates to your working conduct and mode of working and does not involve any direction from the employer / client. As such, there are certain ‘control markers’ to look out for in the contract and to avoid, if you want to be sure of not waking the IR35 gods:
The appearance of starting and finishing times.
The allocation of specific days that the contractor should be working the contract.
The allocation of any lunch breaks, as well as the length of those lunch breaks.
The specific mentioning of any kind of control or supervision by the client over the contractor.
In other words, any contract between two businesses should not involve one party telling the other party what to do in the manner of employer / employee. Rather it should simply be one company engaging the services of another.
Financial Risk – Are You Vulnerable?
Another way to ensure IR35 does not apply to you and your company (and that you don’t incur all the associated penalties and taxes) is to prove that you have the same appropriate financial risks attached to that company as other directors operating similar companies. If you were a general employee of a company you would have no financial risk whatsoever because you would be employed. If you are a director of a limited company then you face financial risks (such as a failure of clients to pay, purchasing assets for the company including equipment etc) and are therefore (supposedly) offered better rewards because you are taking the risk of setting up a company. For a contractor to effectively receive a regular and constant monthly ‘salary’ from one employer through their limited company is to go against the spirit of the regulations and would be a sign that IR35 might be applicable.
Working Obligations – Can They Fire You?
Other IR35 indicators come from the presence of working obligations with clients and if you or the client has the right to dismiss each other at short notice. In the opinion of HMRC, the right of dismissal is a key marker for whether a relationship is one of employer / employee or limited company / client. They have argued that the presence of a fixed notice period in any working relationship marks that relationship out as being too similar to fixed employment. Similarly, they also think that if there is an obligation for you to take on every bit of work that the client offers / gives you then you, or for them to provide you with every bit of work, then the relationship is too much like that of an employer and employee and IR35 would be applicable.
Working Equipment – Does It Belong To You?
Surprisingly, this is another area that HMRC will look at closely when trying to establish the IR35 status of a contractor. They believe that ownership of the equipment that is used to do the work is an important factor in establishing the nature of the relationship between client and contractor. Thus, if the equipment for doing the job is provided by the contractor – be it laptops for designing web pages or writing content, or instruments for taking engineering readings or paint and ladders for painting – then the contractor is buying the assets in their own company and taking out a financial risk (as mentioned above). This is something that employees would rarely do; on the contrary, employees would normally expect their company to provide the equipment necessary for doing their job. As such, if an employer is providing the laptops, the laser measuring devices, the paint or the ladders then HMRC would have another reason to argue that the contractor would come under the IR35 regulations.
Employee Benefits – Do You Get Any?
If you do, you might be in trouble with IR35. It should be obvious but it is still worth stating – if you want to be considered a genuine and legitimate limited company director then you must ensure that you never receive any employee benefits of any kind at any time. Slip up on this one and you could very quickly be sitting down with the HMRC IR35 team. That means your clients can’t offer you holiday pay or sick pay, free training courses or equipment training, or any perks of any kind that would put you in a similar position to one of their employees. You can’t even go to the Christmas party. That’s right, HMRC don’t allow you to party at Christmas!
Substitution Clauses – Worth Inserting
The absence of a substitution clause wont necessarily count against you, but including one will definitely help prove to HMRC that you aren’t an employee. If you put a clause in your contract that the company is providing a service and that if you can’t perform the work someone else will then it quickly becomes clear that you are not an employee of that company. Employees cannot easily be swapped for other employees, obviously. A simple clause that indicates you reserve the right to do this doesn’t mean your clients need to worry about it happening – after all they are hiring you – but it does allow for it to happen should the need arise. Conversely, if you have a clause that all work will be done specifically by you then you would once again move closer to IR35.
That Rainy Day Has Come – The Tax Implications of Getting Caught By IR35.
Basically, if HMRC do conclude that you are under IR35 it’s not going to be fun. The tax implications will be costly as they introduce you to the term ‘deemed salary’ which will mean that any income that you earn / earned from an IR35 applicable contract will now be liable to tax and NIC’s that you might not have counted upon. Your expenses will simultaneously also be massively reduced for that contract because you would no longer qualify for them. And worst of all they will begin looking back at all your contracts with the aim of pursuing any and all unpaid tax and contributions where previously you might have just paid yourself in dividends – a very large bill could follow, as well as heavy penalties that they are entitled to levy.
Check Everything Then Check It Again.
If you’re now sat there thinking about reviewing your IR35 status on present, past or future contracts then the lesson is to look at every aspect of the contract and make sure you don’t fall into any of the traps mentioned here in this guide. From now on adjust your working practices accordingly, or better still, move over to a PAYE umbrella company – they offer a much better way of working (as well as similar tax advantages via expenses for the majority of contractors that use them) but because they involve PAYE and NIC’s can never fall foul of IR35.
IR 35 IN THE PRIVATE SECTOR
In 2020, the Government will roll out similar changes to IR35 in the Private Sector, a much bigger and more diverse pool of contractors. With many more end clients in this sector, competition will be fierce and taking a conservative view (e.g. a blanket approach that all contractors are inside IR35, as adopted by the NHS) may result in difficulties finding candidates who are willing to work within IR35.
As with the public sector, the responsibility for determining IR35 status will shift from the individual to the end client, recruitment agency or another third party engaging with the worker. This is a huge change and the impact of this across the industry will be far reaching. A review of each contract role will require careful consideration, with thought given to the usual IR35 criteria
HOW WE CAN HELP
If HMRC suspects that an incorrect declaration of employment status has occurred, they will open an enquiry. This is an investigation into you, your business and your working practices. This can be incredibly stressful, not to mention time consuming, and being on the end of an adverse judgment can potentially be life changing. HMRC will review your contracts and your actual working practices to identify whether you are self employed or employed. As such, it is best to be prepared by following a sensible approach to equipping your business for the these challenges. There is no easy, one stop shop for this, however, careful planning and consideration can vastly improve your chances of success
Not only can we perform reviews of your compliance with future legislation and quantify the financial impact of getting this wrong, but we can equip your contractors businesses to be ready. We can assist them to stop thinking like contractors and start thinking like business people. By adding layers to their business we can change a Personal Service Company that is only used as a vehicle for invoicing and payroll to a full-fledged business. We can assist contractors to put in place substitution agreements, insurances, working practices that better reflect their status.