You are a contractor as opposed to an employee. You should fall outside IR35. But if the taxman were to take a closer look at the arrangement, would you be able to prove it?
This question is central to the set of tax rules known as IR35. The rules are designed to clamp down on so-called 'disguised employment' whereby a worker supplies their services through an intermediary (e.g. their own limited company) in what is claimed to be a contractor/client arrangement. HMRC’s concern is that some of these arrangements are not genuine and have been set up for tax-saving reasons, and ought to be treated as employee/employer relationships (and taxed accordingly).
Why is the ability to prove IR35 status so important?
The bad news is that if a contract is deemed to be inside IR35, HMRC can demand income tax and NICs plus penalties and interest - and this can apply to past contracts, too.
The much better news is that by preparing for the possibility of a contract inspection, by understanding what inspectors look for, and by producing evidence in support, you are in a much stronger position to prove that yours is a genuine contractor/client relationship that falls outside of IR35. Here’s how to do it…
What is the taxman looking for in your IR35 determination? The three tests explained…
If you are faced with an enquiry into your employment status, what exactly is the tax inspector looking for?
As you would probably expect, the inspector is going to want to take a good look at the contract between you and your client. That’s why, if you haven’t already, you should take a look at our contract clause examples here.
That said, (and this really can’t be stressed strongly enough!), the wording of the contract itself is not regarded by HMRC as cast-iron proof of your status. To decide whether you are a contractor or an employee, tax inspectors will look closely at your actual working practices.
To examine these, HMRC inspectors use three principles - also known as the ‘tests of employment’. These are as follows:
- Control: Employers tend to keep close supervision, direction and control over their employees, dictating matters such as what, how, when and where the worker completes the work. For contractors, so long as the agreed work is completed, it is for the contractor to decide how it is done.
- Substitution: Employees are required to provide personal service: they cannot, off their own back send in someone else to work in their stead. If a worker is allowed to supply a replacement (i.e. a substitute) under the arrangement, this can be strong evidence that they are indeed a genuine contractor.
- Mutuality of obligation: As an employee, you turn up to work, you are paid each month and in return, may be expected to complete tasks across a wide range of activities. A contractor’s role tends to be much more tightly defined; it’s restricted to specific tasks, usually linked to a particular project. And once it’s over, you move on. You might be offered a new contract, but you are certainly under no obligation to accept.
Proving your IR35 status: Evidence needed for passing the tests
Once the contract is underway, it’s extremely helpful to collect and keep hold of evidence that shows you are a contractor as opposed to an employee. Memos, email threads, work logs - even evidence linked to other projects you are involved in - can all be helpful in proving your case.
Useful evidence includes the following:
Proving absence of control
Your personal work logs can help show that you dictated precisely when you worked. If much of the work is done from home (thereby showing that you controlled where you worked), make sure those work logs and similar records are clear on this.
Especially if you are required to attend the client’s premises, keep hold of evidence that shows you are not treated like ‘part and parcel’ of the organisation. Simple indicators such as visitor sign-in records and car park passes can be useful here. You are not a member of staff so (as tempting as they may be), be very wary of signing up to staff perks if they are offered - such as staff canteen privileges, season travel cards and gym membership.
Try to control the tone of communications with your client. For instance, if it appears you are asking permission to be on-site on particular days, as opposed to informing your client of your schedule, it becomes easier to wrongly infer the existence of an employer/employee relationship.
Proving a right of substitution
If you actually need to appoint a substitute (e.g. due to illness), then keep all records relating to this. Even if the need to engage a replacement does not arise, it helps to be able to show you could rely on the right of substitution if needed.
Consider obtaining written confirmation from the client that they would be willing to accept a suitably qualified substitute, chosen and paid for by you. Also, if you are aware of any situations where other contractors in a similar role have engaged substitutes with that client, obtain details of this.
Proving absence of mutuality of obligation
Communications showing you have declined offers of contracts with this client in the past may help to show that you are not under any commitment to take on additional work from the client. Likewise, flag up any instances where you have politely declined requests to carry out tasks that are outside of the agreed scope of the contract.
Why is IR35 status important, and how to protect your position
If a tax inspector suspects that your contract is within IR35, then, at the very least, you will be faced with the hassle of responding to the taxman’s enquiries. Most important, you can be hit by a higher than expected tax and NI liability relating to your current contract, as well as possible demands for repayments relating to previous contracts as far back as six years.
For essential advice relating to all aspects of IR35, take a look at our Knowledge Hub. Did you know that IR35 insurance can cover you for the cost of defending your case and for your liability for tax back payments (if your case meets the correct circumstances)? For more information, get in touch.