Guide to IR35
Intermediaries Legislation, more commonly known as ‘IR35’, was originally introduced in 2000 and was intended to
- Stop artificial arrangements where employers reduce their workers’ tax and NI, paying them dividends via a separate company, rather than a direct salary i.e. ‘disguised employment’.
- Collect more tax from agency workers, who were often encouraged to form their own companies in order to be paid as dividend.
The rules require an employment status test to be undertaken for any worker paid via an ‘Intermediary’ – usually the intermediary would be a ‘Personal Service Company’ (PSC) controlled by the worker.
In these situations, the contract and working arrangements with the end client should be reviewed in order to establish whether the nature of the engagement might essentially be one of employment.
Where the person providing their services would have been considered an employee, had they been working directly with the end client, then Intermediaries Legislation (IR35) is deemed to apply. In practical terms this usually means the worker being paid salary by their PSC (i.e. subject to tax, and employee & employer national insurance) rather than dividends.
If the engagement is assessed as being ‘outside the scope’ of IR35 (i.e. IR35 does not apply), then certain travel expenses to temporary workplaces become allowable, and salary can often be reduced in favour of dividends (dividends attract tax, but not NI) - All of which increases the overall ‘take home’ of the worker.
In recent years Government has rebranded IR35 as ‘Off-payroll’ working, and different rules currently apply to the Private and Public Sectors.
Public Sector – the Public Authority (End-Client) is responsible for deciding whether off-payroll working rules apply. If they do, then tax and NI (Employees and Employers) are deducted in full before any amounts are paid to the worker’s company.
Private Sector – person providing the service (usually also the company director and shareholder) is responsible for deciding whether IR35 rules apply, and calculate appropriate salary levels where the rules do.
IR35 should be assessed separately for each and every contract. You have to decide whether that particular engagement is actually ‘disguised employment’. If someone from outside looked at the work you are doing, and your relationship with your end-client, would you seem like an employee? Are there enough things (written in the contract, the type of work you’re doing, the responsibilities you have, etc) that point to you being properly self-employed?
If you decide that your engagement looks more like what a regular employee does, then it is safer to pay earnings as salary. If you don't it will be risky if HMRC choose you for an inspection: you'll owe the difference between the tax and NI already paid and what would be due as an employee. You might also be assessed for penalties and interest on top.
You’re probably thinking 'I’m a pukka, professional contractor, not a chancing wide-boy, so I’m OK'. That’s fine, and the fact that you’re one of our clients reinforces this – we try to avoid taking on chancing-wide-boys (or girls).
That said, there is a huge difference of perception between the consultancy market’s opinions on IR35, and the views of Government and the Tax Authorities. HMRC indicate they consider IR35 should apply to 90% of freelancers working through their own companies. Although this proportion is not backed up by the win stats for cases HMRC has pursued, it is fair to say that there are freelancers who decide to trade ‘outside IR35’ when in fact the work they are doing is very similar to regular employment.
In reality the more specialist, short term, highly paid and independently managed your work the more likely IR35 legitimately won't apply. If you've doubts about your status then one way to reduce risks is to pay yourself a higher amount as salary.
Deciding you're caught by IR35, and paying earnings as salary isn't always the end of the world, and loads of freelancers come to this conclusion. The difference in take home amounts usually equates to between 5%-15% of day rates (depending on your level of earnings). There are restrictions on what travel expenses can be claimed though, and this can often make things trickier where projects involve staying away from home.
You'll need to bear with us here - some of this gets quite theoretical and a bit jargony.
To assess IR35 status HMRC will construct a notional contract; this contract doesn't really exist but is a way of evaluating whether, if there were no intermediaries (i.e. no limited company, agency, etc) involved, would the workers relationship with the end-client be closer to employment or self-employment?
Three of the main status indicators are:
IR35 Indicator - Right to substitution clause
Can a substitute be sent if you're sick for a long period, on holiday, or the substitute has certain technical skills required for a particular task? If so, how fettered is that right to substitution? – i.e. does the substitute need to be agreed in advance? Or is the client simply entitled to refuse a substitute irrespective of whether they may have the necessary skills? If a client only allows a substitute after a formal interview and written permission, then it is unlikely to be accepted as a clear right of substitution.
If a right to substitution clause exists then HMRC would try to establish whether or not it was genuine. Has a substitute ever been sent? Who picked up the cost is an absolutely key point. Documented proof will be examined and many freelancers will agree a written procedure with their end-clients on the process for sending a substitute. This will cover access to the building, computer access, adhering to site policies, etc..
IR35 Indicator - Mutuality of obligation (MoO)
This is a complex area of law with subtle variations of interpretation. Broadly Mutuality of Obligation (MoO) boils down to whether the client is obliged to pay for simply turning up to site, just as there would be if an employee shows up to work. It would be very difficult to argue that there was an absence of MoO where a contract doesn't allow a client to terminate immediately.
Any reliance on a MoO clause must reflect the real situation. MoO is more likely to keep a freelancer outside IR35 where terms are mirrored within each contract in the supply chain, and confirmed separately in writing between the end client and the freelancer.
IR35 Indicator - Control
For IR35 to apply there must be control over how the work is done. The broader the contractual objectives and timeframes the better for IR35. A freelancer dealing with issues as they happen within an organisation is in a weak position. Working on set projects, agreeing defined milestones and timeframes and working from your own offices would all be positive indicators that the worker has control.
If there is an agency involved then you may not know the details of the upper contract between the agency and end-client. A freelancer may benefit from confirming in writing the reality of the underlying arrangements with the end-client.
IR35 - Forming An Opinion
If all three of these suggest the freelancer is caught by IR35 then it's unlikely that other factors will have any bearing. If there are aspects of employment and self-employment then secondary factors such as ‘financial risk’ and being ‘in business on own account’ will be tested:
Financial Risk - assessment includes risk of not being paid, sick pay arrangements and employee-type benefits, fixed-price job-costing.
In Business On Own Account – business has office facilities, website, stationery, employees, marketing, training, public & employer liability cover, professional indemnity cover, other projects under. Not part-and-parcel of the End Client organisation.
Once the principals behind IR35 legislation are understood, many freelancers are comfortable deciding upon contract status without professional help. Complacency is dangerous as a strong audit trail is essential; all contract assessments should be accurately and honestly documented.
A definitive answer on your IR35 is always going to be tricky. It’s difficult to get a 100% cast iron guarantee that IR35 doesn't apply and responsibility rests with the worker. There are several routes open to you:
- Ask us what we think. As part of our normal watching-your-back-stuff we’re interested to talk to you about new contracts as you get them, and let you know if we think you need specialist advice.
- HMRC offer an IR35 assessment service. You can write to, or email, the IR35 unit to get an opinion on an existing contract; if you're fairly confident and want to be sure then this might be the thing to do. Although the written contract is important, HMRC will wish to establish the underlying working arrangements – this often means contacting the End Client. Be careful, as if you disagree with the decision, then challenging HMRC might mean visits to the Commissioners or even the law courts. Many freelancers decide the HMRC option is a bit like driving home late at night, pulling over to wave down a police car, and asking them to check whether the tread on your tires looks OK.
- Form your own opinion. Review your contract and come to your own decision on self-employment. Make sure you've documented all the reasons for your conclusions. Joining a group like IPSE entitles you to legal support through any investigations.
- Get legal advice. Some specialist legal firms offer an assessment service. You’ll usually have to pay around £150-£200 for a contract review - perhaps more for a package including insurance. Ultimately, any legal assessment relies heavily on the answers you provide related to actual working arrangements. A positive assessment should provide peace of mind and, so long as your responses are honest, there is the benefit of some serious legal backup if HMRC challenge the assessment. We'll happily pass on contact details of advisors our other clients recommend.
Remember, HMRC are interested in the genuine working arrangements as well as what the contract says; however, the contract itself remains the most significant indicator of IR35 status.
If you decide that IR35 did not apply then be well prepared in case HMRC do pick you out for an investigation. If you've got documentary evidence of spending time deciding on the contract's status and the reasons for your decision, then any penalties will be far less if you've ultimately got something wrong in an IR35 status audit.
In an investigation HMRC may start off assuming you’re holding out on them; it's best to be prepared with evidence that you’re running a proper consultancy business. If there is an agency involved in a particular contract, and your relationship with the end client is a good one, then documenting the real arrangements might be helpful; remember it must be accurate as you might need to rely on it in court.
Passing an IR35 audit is a bit like passing a driving test. You can drive safely and competently and still fail a driving test on a technicality. Same with IR35. it’s difficult to be sure exactly what the inspector will look for; they'll weigh up many different factors and try to build an overall picture of the engagement. Initially, the strongest status indicator is the contract you signed. As time goes by the underlying working arrangements become key.
If there is an agency involved HMRC may also decide to look at the contract between the agency and client. Important elements of the contract(s) and working arrangements, might include:
- That the written terms are relevant to the work you are doing - tailored to the project, rather than a generic template.
- There are substitution clauses, allowing appropriately skilled alternative workers in your place should it becomes necessary. Ideally there would be evidence of actual substitution at your expense, or evidence of an agreed procedure with the client.
- Whether the client can terminate without a notice period?
- If the worker, rather than the End Client, has day-to-day control over what, when, where and how work is completed?
- Is the contract project-based, with defined deliverables and milestones?
- Are there financial penalties for missed deadlines and contract delays?
- Would mistakes be fixed at your own expense?
- Is the business working exclusively for a single End Client?
- Do you work with your own materials (Laptops, software, specialist tools) on site?
The more of these points that indicate self-employment, the better the chance that the assessment will decide that IR35 does not apply.
From 6th April 2017, responsibility for assessing IR35 status (now referred to by Government and HMRC as ‘Off-Payroll Working’), shifted to the End-Client (i.e. the public sector authority). Previously it was the Intermediary (usually the individual worker’s own company) that decided the status of each engagement. For now, Private sector rules remain unaffected.
Where the public authority decides that the ‘Off-Payroll Working’ rules apply, then they (or recruitment agency if there is one in the supply chain) will be responsible for deducting Tax and NICs (both Employees and Employers NI), before paying the balance (the ‘deemed direct payment’) to the worker’s personal service company.
The public sector authority (PSA) have full autonomy to develop their own procedures in forming IR35 status decisions, often this may involve seeking legal advice and contract reviews. Most PSAs will utilise the ‘check employment status for tax’ flowchart in forming their IR35 opinion (available at https://www.tax.service.gov.uk/check-employment-status-for-tax/setup). Although not definitive, the outcome will carry substantial weight in any subsequent HMRC compliance.
The most common scenario where HMRC’s employment status test returns a decision that IR35 does not apply is where the intermediary has the right to send a substitute worker. There does not necessarily have to be an occasion where it has happened; however, the right has to be a genuine one.
Where IR35 does appy, the difference in 'take home' amounts often equates to between 10%-15% of the consultancy day rate (depending on the individual's level of earnings). Restrictions on travel expenses increase this disparity and can often mean it is impractical to accept a project with a long commute or which involves staying away from home. Of course, headline 'take home' percentages only tell part of the story. In reality, the opportunity to trade 'outside IR35', allows the flexibility to build funds within the business, contribute to pensions, and decide when profits are withdrawn and therefore when tax charges are triggered.