Since being introduced in April 2000, it’s undeniable that IR35 has been controversial. Despite numerous case studies having been made about the contractor fall-out from the IR35 reform, it’s often overlooked as to how you can help yourself, as a freelancer, while continuing to work in the private sector post-April 2020.
Freelancing comes with a lot of responsibility; being aware of your legal duties towards your client, understanding the implications of your advice and designs and ensuring you’re paying the right taxes are all parts of being self-employed. With IR35 changes to the private sector looming, these responsibilities will be tenfold; your client will be determining your employment status, so it’s imperative that you make sure your contract is fool-proof.
We’ve written some advisory rules to help you navigate working in the private sector post-IR35 roll-out.
What will IR35 change in the private sector?
Let’s start with 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 original aim is a fair one, the aggressive methods adopted by HMRC when identifying so-called ‘disguised employees’ have been heavily criticised. Despite various amendments to IR35 over the years, successive Governments have claimed that too many limited company owners are still illegitimately working outside the rules.
As a result, new ‘off-payroll’ rules were implemented in April 2017 for contractors working for public sector organisations. Instead of contractors themselves being responsible for determining their IR35 status, this obligation has been handed to the engager of each contractor, i.e. the client.
Where a client deems the contractor to be ‘inside’ IR35, they must deduct employees’ NI contributions and income tax from the contractor’s pay.
Unfortunately, the tools and information required for clients to make an informed choice have been widely criticised (particularly the online CEST tool), and given the penalties for making an incorrect employment status determination, some clients have opted to make blanket ‘inside’ IR35 decisions.
Much of the same can be expected when IR35 is introduced to the private sector. It’s been noted by industry experts that the private sector is much more diverse in its nature and so the tools which are already unfit for use in the public sector will be even less appropriate in April 2020.
Who will be affected most by IR35?
Because the private sector is such a varied place to work in, it’s difficult as a freelancer to know when you’re at risk. Contracts can vary from client to client and project to project, so it’s important to be able to spot a compliance risk as soon as it presents itself.
Contractors in the following industries should seriously consider an IR35 contract review, to prepare for a potential investigation:
- IT and Technology
- Banking and Finance
- Energy Sector
- Business and Management
- Media and Creative
If your particular profession isn’t included in the list above, it's advisable you have your contract checked, regardless.
What are the biggest IR35 contract mistakes?
The CEST tool, which has been widely used and widely slated for employment determinations, omits one of the most important aspects of classing a person as inside or outside IR35 called Mutuality of Obligation (or MOO). We'll explain this in full further down but it's crucial to make sure that every aspect of your contract is bullet-proof - the whole picture may not be taken into consideration.
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 - as opposed to a contract of services - and can cause you to fail an IR35 test. Freelancers 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. Freelancers 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.
Freelancers 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 caught 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 IR35 insurance 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 & Liabilities 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.
Take a look around our Knowledge Hub for more contractor guides, IR35 news and expert advice.