IR35, also known as ‘intermediaries legislation’, or ‘off-payroll working legislation’, is a tax law which seeks to ensure no tax advantage is gained by disguising employment as self-employment.
‘Disguised employment’ is where a contractor appears to be working for themselves, but in reality acts like an employee of their client.
If this sounds confusing, you are not alone, the rules which govern when IR35 applies are extremely complex, making it very hard to be compliant with the legislation. HMRC frequently lose IR35 cases at tribunal, which has led to criticisms that even HMRC doesn’t understand the rules.
How does IR35 work?
IR35 is based on case law, and therefore built upon the outcomes of each individual case. It works on an engagement-by-engagement basis, meaning it looks at the nature of each contract with a client, not at individual companies.
How is IR35 status determined?
It’s complicated, but there is one basic rule to bear in mind: does the engagement look and feel like employment? If it does, it is more likely IR35 will apply. To help the courts understand what ‘looking and feeling like employment’ really means, they have come up with three main factors to consider, and a handful of supplementary ones.
The three main factors are:
Personal service/substitution
Are you required to carry out the work yourself, or you can you send a substitute to do it in your place? Employees cannot send a substitute, so being required to offer personal services points towards IR35 applying.
Supervision, direction, and control
What degree of supervision, direction and control does your client have over what you do? Do they tell you how to do the work? Employees are controlled by their employer, so the existence of control points towards IR35 applying.
Mutuality of obligation (MOO)
Is your client obliged to offer you work beyond the agreed project, and are you obliged to accept it? Employees and employers have mutual obligations, so the presence of MOO points to IR35 applying.
You’ll need to be able to demonstrate that at least one of these factors does not apply to your contract and working practices to avoid IR35 applying. For example, if you have an unfettered right to send a substitute, IR35 doesn’t apply, regardless of control and MOO.
Supplementary factors
Sometimes it’s not clear whether the factors above apply or not. In these instances, the following may be taken into consideration:
Part and parcel
How integrated into the client business are you? Are you ‘one of the team’ or is it clear to everyone that you work separately? Separation from the client business is a good indicator that IR35 doesn’t apply.
Use of your own equipment
Employees use equipment supplied by their employer. Independent contractors use their own equipment. This test doesn’t always work in practice. There are often good reasons – such as safety and security – why an independent contractor would use the client’s equipment.
Financial risk
If you make a mistake, do you fix it on your own time, or the client’s? Independent contractors would typically be expected to fix it on their own time.
Did you go to the Christmas party?
This one is sometimes jokingly referred to but there is an important point behind it. Do you attend staff entertainment events, paid for by the client? If so, it could be unhelpful for your IR35 status.
In an IR35 tribunal, the judge will consider all these factors and others to try to determine if, were it not for the existence of your limited company, the relationship would be considered employment. If the judge decides that it would, IR35 will be applied.
What can I do to comply with IR35?
There are a few simple steps you can take that will dramatically reduce the risk of IR35 being applied to your engagement. The key is to make it clear to all parties that you are not an employee and should not be treated like one. If you have the following in place, it will make it much easier to explain to a client, agency, or indeed HMRC, that IR35 should not apply.
It’s all about putting clear daylight between you and your client’s employees. The clearer it is that you are not a ‘disguised employee’, the better it will be for your IR35 status.
What happens if IR35 applies?
If IR35 applies there is an increased tax liability. Essentially, the government is looking for the tax that would have been paid, had the engagement been deemed employment.
Public sector changes
Since April 2017, in the public sector, clients have had to determine the IR35 status of engagements. Where IR35 is deemed to apply, the fee-payer (the entity in the chain which pays the contractor) must ensure those payments are made via the RTI system – meaning tax is deducted at source, as it is for employees.
Private sector changes
The off-payroll working reforms (IR35) were implemented in the private sector on 6 April 2021 and moved the responsibility for deciding the employment status of freelancers, to the end-clients for medium and large sized private business clients.
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