Whether you’re new to contracting or you’re a freelancing veteran, you’ve no doubt found your way here because you’ve stumbled across the term ‘IR35’.

Frankly, there’s a huge amount of fear-mongering and mixed advice around the subject. Many articles assume you already understand the often obscure terminology and tell you what to do about IR35 without taking a breath to even explain what it is.

So, we’re taking it back to basics.

What is IR35?

Watch our quick video to get the basics of IR35 in just one minute:

The term IR35 itself is shorthand for Intermediaries Legislation, as coined by then-Chancellor Gordon Brown back in 1999 during the pre-budget speech. It’s literally short for ‘Inland Revenue 35’. This was the legislation’s unofficial name, which was mistakenly included in a press release for the budget and has stuck ever since.

The legislation was originally introduced to challenge perceived tax and National Insurance Contributions (NICs) avoidance by disguised employees through working via the use of partnerships and limited companies.

Let’s break that down into English.

‘Perceived tax avoidance'

is very different from tax evasion. To start with, tax evasion is illegal while tax avoidance is not. Perceived tax avoidance is, in it’s most basic form, simply finding a loophole to increase your take-home pay and using it.

Disguised employees

are workers that are contracting for a company on paper, but are to all other intents and purposes an employee. They have set working hours, typically only work for one client and may be expected to accept all work asked of them by their employer. However, they aren’t subject to income or NI tax like a traditional employee so benefit from much higher take-home pay. This could be seen as unfair on those doing the same role with an employee contract – and subsequent taxes - by some.

Partnerships and limited companies

are used to set up the ‘contracting on paper’. Many contractors use Personal Service Companies (often referred to as PSCs) to supply their services to either the end client directly or through an agency. There’s no official definition of what constitutes a PSC in law though, which is where things can get a little tricky in terms of IR35.

Who is IR35 aimed at?

IR35 targets contractors, freelancers and any self-employed person that is perceived to be taking part in tax avoidance through the use of PSCs or any such like company.

If you are found to be ‘inside IR35’, then HMRC has determined that you’re a disguised employee and you should be paying income and NI contributions.

So what does it mean to be inside or outside IR35?

Inside IR35

means that HMRC classes you as a disguised employee, and that you should, therefore, be paying tax as if you’re an employee. You would still have a contractor’s contract with your employer however, so you won’t benefit from employee rights like holiday, sick or redundancy pay. Being found inside IR35 could also cause severe financial implications to your monthly income.

Outside IR35

is the direct opposite (and the one you want to be). This means that HMRC classes you as a legitimate, genuine contractor that has to pay their own overheads, necessitating the tax break that comes with self-employment.

Why is IR35 seen as bad for contractors?

At the time of IR35’s conception back in 1999, the tax system was vulnerable to abuse.

It was incredibly easy to change employment status with almost immediate effect. Despite this never being made illegal, employees who falsely changed themselves to contractors (i.e. ‘disguised employees’) - and essentially keeping the same role with the same company - were avoiding huge amounts of tax, causing a revenue leak that sent HMRC into panic.

Needing a quick solution, IR35 was launched without proper testing or a realistic roll-out timeline in place. It began impacting the livelihoods of genuine contractors and freelancers, with many having to contest HMRC’s decisions in order to continue practicing their profession.

The legislation itself is now perceived as the contractor’s bogeyman. Continuous, though not undeserved, bad press about the tool HMRC uses to work out if you’re inside or outside IR35 (called CEST) has made many contractors fearful of the financial implications of an investigation.

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.

Read more about the usual tests that are used to make IR35 determinations and the steps you can take to make sure you’re bona fide in the eyes of the taxman here.

See here for even more information on IR35 and how you can protect yourself against an investigation, or take a look around our Knowledge Hub for more contractor guides, IR35 news and expert advice.