We discuss the effects of IR35 a great deal but it’s easy to forget that thousands of contractors are still yet unaware of the legislation itself, or the impact it could have on them. It’s based entirely on complicated case law and there’s a (convincing) argument that not even HRMC knows how to implement the legislation, making it easy to see why it’s such a murky subject.
So, what exactly is IR35 and what can you do to protect yourself from it?
What is IR35?
Quite literally, IR35 is an abbreviation of ‘intermediaries legislation’. This is a set of tax rules that apply to those that work via an intermediary to provide the end client with a service – a limited company or personal service company (PSC) are the most common instances.
Let’s give some context:
An engineer is contracted by CarCo. He is hired and paid through his own limited company. This limited company is the intermediary between him and CarCo, the client, and means that he isn’t providing his services directly. He doesn’t have an employment contract and is therefore exempt from paying National Insurance tax, but doesn’t receive holiday or sick pay and must supply his own tools. This tax relief allows him to set aside enough money to pay for his overheads.
The purpose of IR35 is to identify individuals that are abusing the above system to avoid paying tax.
Whilst the cause is a fair one, the aggressive methods that HMRC have adopted when identifying so-called ‘disguised employees’ have been heavily criticised. A high-profile ongoing case is that of Eamonn Holmes but there have been numerous investigations throughout the NHS, BBC and even HMRC itself to name just a few.
How is my IR35 status determined?
HMRC commissioned a tool called CEST – an acronym for Check Employment Status for Tax – which has been widely used, and widely slated, for IR35 determinations.
There are 3 main points to consider when determining IR35 status:
How much control do you have over your working day? If you have the below in your contract, you could be considered inside IR35:
- inflexible start and finish times
- specific days you must work for the client
- lunch break times and duration
- specific clauses stating the client has supervision and control over your work.
All of the above usually appear in a contract of employment and can cause you to fail an IR35 test. Contractors have control over when and how they work by definition.
Can you supply a substitute? If you aren’t well enough to attend a job, could you send someone in your stead to complete the work? If so, then you would most likely fall outside IR35.
However, there should be a right of substitution clause in your contract specifying your right to do so as a contractor – if the client has specified that you can’t supply a substitute under any circumstance, then you could be in trouble. Contractors are free to send someone else in their stead, provided the work is completed to an equal standard.
Mutuality of Obligation (MOO)
Can you choose the jobs you work? Does one main client dictate whether you can accept other clients while working with them? If your contract specifies exclusivity or states any amount of obligated hours of work a week at a set rate, then you could fail IR35.
Contractors are able to take whichever projects they choose from whatever client they wish to work with. They should also be free to turn down work from any given client.
HMRC’s CEST tool currently omits MOO, which is a weighty consideration in whether an individual can be classed as a contractor or not. To compensate, make sure the rest of your contract is watertight against Control and Substitution checks as well.
What happens if I’m found inside IR35?
If you fail an IR35 test, you can expect to pay around 25% more in tax every year, which would amount to a huge chunk of money absent every month. You also still wouldn’t benefit from employment rights or have a contract of employment with your client, so you could face critical financial issues with no real benefits or protections to speak of. It’s important to take the necessary precautions to avoid this situation.
Of course, if you are a genuine professional contractor, freelancer or consultant who is in business on your own account, you shouldn’t have anything to worry about. Read up on how the legislation works and apply best practice. It would also be worth having a defence prepared in case you’re investigated by HRMC; whilst you may know that you’re legitimate, IR35 determinations are notoriously subjective.
Should you want some peace of mind, we offer a full contract review amongst other services to help you prepare for IR35. We’ll give an explicit pass or fail based on the current contract you hold, along with comprehensive comments on how to improve any problem areas.
We also offer IR35 tax investigation insurance (TILI) which protects against the court costs that could arise from an HRMC case. It also covers representation by a tax specialist at a tribunal.
For any further information or advice, please call us on 01163 800 400 or email [email protected].