Knowing the basics of IR35 is essential for contractors as HMRC readies itself to roll out the biggest changes yet to its tax rules. Despite being roundly condemned by the general contracting community, as long as you’re prepared and know how the legislation works, it's entirely possible to continue your self-employment.
IR35 is specifically targeted at people who supply their services to clients via their own limited company, often called a personal service company (PSC), or a limited liability partnership. HMRC originally introduced the legislation in 2000 to combat so-called 'disguised employees', challenging limited company contractors over their employment status for tax purposes and deciding whether they should, in fact, be taxed the same way that a permanent employee should be. New changes, set to be introduced in April, will shift the responsibility of employment status determinations from you to your client.
It’s worth knowing how the rules work, then, and what you need to consider in your upcoming contracts. Education is key to being able to communicate to your client which side of the IR35 reform you feel you sit.
Employed or self-employed? A simple scenario
Let’s start with the scenario that HMRC uses as an example in one of its IR35 factsheets to distinguish between someone it considers as being employed for tax purposes and someone it considers as self-employed for tax purposes:
HMRC deems this person to be self-employed for this contract (outside IR35)
Alan is taken on by a manufacturing firm to design and build a new website. Alan and the firm have agreed on a price for the job and when he will deliver the new website. Alan will mainly work at home, using his own equipment to complete the task. Alan is free to work for other clients but faces a contractual penalty if he doesn’t deliver the website on time, to the agreed standard. This represents a significant financial risk to Alan if he fails to deliver the final product as agreed.
HMRC deems this person to be employed for this contract (inside IR35)
The manufacturing firm needs someone to maintain and update the new website. It hires Zainab to work for three days a week, eight hours each day. The firm provides Zainab with a laptop so she can work at its offices or at home with permission. She reports to the head of the IT department and must follow their style guide and format to update the website. The firm is responsible for providing and updating the software Zainab needs to do her work. If Zainab has to work longer than her contracted hours, she will be paid overtime. Zainab can work elsewhere on the days she is not working at the firm, with their agreement.
Key factors that determine an IR35 status
Using the example above and drawing from the questions HMRC asks in its CEST tool (read here to understand more about the tool and its flaws) there are some clear pointers that distinguish a self-employed individual from a disguised employee in the eyes of HMRC. They are:
Substitutes and helpers
Could you send someone else in your place to carry out the agreed work, assuming they are equally qualified, and meet your client’s interviewing, vetting and security clearance procedures?
What degree of supervision, direction and control does your client have over what, how, where and when you complete your work?
Will you have to fund any vehicle costs or buy materials before your client pays you? If the client was not happy with your work, would you have to put it right?
Mutuality of obligation
Is your client obliged to offer you work, and are you obliged to accept it?
These principles are all used by HMRC to determine your employment status for tax purposes. To avoid being affected by IR35, you’ll need to demonstrate that you’re operating as a genuine business, which means your client has accepted or would accept a substitute, you determine your own working arrangements, you or your business will have to fund costs before your client pays you, and your client is not obliged to offer you work nor are you obliged to accept it.
How to avoid IR35 in new contracts
To demonstrate to HMRC that you’re working on a business-to-business basis, and therefore you sit outside IR35, it’s important that your contracts and working arrangements take into account the following:
- Your client must be willing to accept a substitution in your place when necessary. Any substitution clause will likely fail under HMRC scrutiny. So, if they are only interested in you and your skills and won’t accept a substitute, it’s a good indicator that you’re an employee and are not self-employed, therefore your contract would fall within the scope of IR35.
- Supervision, direction and control clauses should never appear in a contract. It should be up to you over when, where and how you work, not the client. Equally, if you find yourself having to submit to management guidance, appraisals or monitoring, it’s likely that HMRC will conclude that you’re under the control of your client and therefore an employee.
- Similarly, a genuine self-employed contract must state that the client has no obligation to offer you more work and you have no obligation to take it. It’s also worth avoiding provisions to extend the contract to be on the safe side.
Other factors to consider
As a limited company contractor, one of the main reasons you pay less in National Insurance Contributions (NICs) is because you don’t get any of the employment safety nets that permanent employees receive through their jobs. That includes things like holiday pay, sick pay and a pension. So, if you find yourself committing yourself to a contract where some of these perks do apply, it’s highly unlikely that this particular working arrangement will fall outside of the scope of IR35.
The same goes for taking on any management responsibilities for your client, or becoming integrated with the organisation and appearing in organisation charts and so forth. If you're in a position where you’re deciding for your client how much to pay someone, hiring or dismissing workers, and delivering appraisals, or you’re fully part of your client’s organisation structure, it’s very likely HMRC will consider you a 'disguised employee'.
Assuming you want to continue operating as a genuine contractor outside of IR35, it’s worth distancing yourself from your client’s corporate structure and only taking on responsibilities not specified as part of the project when this is the industry norm, such as safety responsibilities.
While tools like HMRC’s CEST are supposed to help contractors and hirers to determine the IR35 status of each contract, it's notoriously inaccurate - it's advisable to seek independent specialist advice. Larsen Howie provides a comprehensive range of IR35 reviews, carried out by our specialist IR35 team who know the legislation inside out. Please do get in touch by calling us on 0116 380 0400 or sending us an email if you need help. You can also check out our Knowledge Hub for more IR35 insight and guidance.