A brief history

So what is IR35? We explore the subject in this quick IR35 guide for contractors.

IR35, also referred to as the intermediaries legislation and more recently as the “off-payroll working rules,” is a piece of UK tax legislation introduced in the year 2000 through Chapter 8 of the Income Tax (Earnings and Pensions) Act 2003. Its purpose is determining employment status for tax purposes.

IR35 is relevant to individuals who offer their services or work through an intermediary entity, such as a limited company (sometimes referred to as a “personal service company”) or a partnership. Trading through a limited company in a genuinely self-employed capacity offers certain tax benefits, mainly to do with the tax treatment of “dividends”, of which you are entitled to payment of as a shareholder. However, prior to the implementation of IR35, taking advantage of these tax benefits by working through a limited company was vulnerable to exploitation.

In essence, the legislation aims to address “disguised employment” by ensuring that individuals who receive payments from a client or engager through an intermediary and have a working relationship similar to that of an employee, are taxed in a manner consistent with employees.

What IR35 is today

IR35 has to be considered for each and every contract you undertake.  Historically, the responsibility for determining IR35 status (whether “inside” or “outside,” indicating IR35 applicability) and ensuring proper tax compliance rested with the contractor who worked via their limited company.

In 2017, a significant change occurred, shifting this responsibility to public sector clients for engagements with them. As of April 2021, these rules expanded to include medium and large private sector clients. These newer rules are covered in Chapter 10 of the Income Tax (Earnings & Pensions) Act 2003.

So, as it stands today, contractors working for either public sector or medium and large private sector clients can no longer decide their status – instead their client is the party responsible for making this decision and issuing a “status determination statement” (SDS), which confirms if the contract is “inside” or “outside”, and the reasons why.  Additionally, the “fee payer” (typically the client if the contract is direct, or an agency) is required to make “deemed employment deductions” at source if the engagement is determined as inside IR35.

These newer (Chapter 10) rules now govern most limited company engagements.  However, there are still instances where the contractor is responsible under Chapter 8, either for engagements with “small” clients (as defined by the Companies Act), or wholly overseas clients not within the UK tax jurisdiction.

Under both sets of the rules, the responsible party is obligated to take “reasonable care” in their status decisions.

What is the difference between inside and outside IR35?

• “Inside IR35” – the relationship with the client amounts to employment for tax purposes and therefore employee rates of tax are due on the entire income. This is either deducted at source by the fee payer for engagements under Chapter 10, or handled in your company tax returns where you are responsible under Chapter 8.
• “Outside IR35” – the relationship with the client reflects that of genuine self-employment. Your payments will be gross and you are entitled to the tax advantages of working for your own business, notably deciding your own salary and being able to draw profit out as dividends. Where contractors want to be!

How is IR35 status decided?

While the changes to the IR35 regulations have shifted the responsibility for determining IR35 status, the fundamental criteria that decides status remains the same, and is rooted in decades of IR35 and employment status case law.

In determining status, it is crucial to assess both the contractual agreement and, more significantly, the actual working practices apparent in the daily interactions between the individual worker and the client.

Here is a high-level look at some of the main factors that decide status and must be considered for each and every contract:

Control: This relates to the client’s rights and the extent of control they exert over the worker. It looks at control over ‘what’ tasks are performed and the ‘how,’ ‘when,’ and ‘where’ of their execution.

Personal service / substitution rights: This involves whether there’s a requirement for a specific individual to perform the work or if the client would accept anyone with the necessary skills and qualifications.

Mutuality of obligation: This relates to whether there is a reciprocal obligation between the client and the worker to offer and accept work, both during and beyond the termination of the contract.

Financial risk: This focuses on whether the worker assumes financial risk, which includes costs incurred in completing the work, responsibility for defective work and negligence, and the basis of payment.

In business on your own account: whether the worker is operating as a true business, with things such as multiple clients, own equipment and office, employees, business insurance, branding and websites.

Other factors to consider are the presence of employee rights or benefits, the worker’s integration within the client’s organisation, exclusive service arrangements, and shared intentions between both parties.

This list is not exhaustive, and each of these factors contributes to forming an overall picture that must be assessed in its entirety.

A final word: the importance of getting it right

To wrap up this IR35 guide, here is a quick summary:

If your client is a public sector or medium/large private sector organisation – they are responsible for the status decision and must issue you with an SDS confirming their decision and the reasons why.  You should ensure you have this before you start or sign any contracts.  If “inside”, the tax/NIC will be deducted at source from whoever pays you and you have the right to appeal if you do not agree with the determination. Either the client or fee payer is on the hook if they’ve got things wrong.  

Tip – keep a look out for any indemnities in your contract that attempt to pass tax risk on to you – we see them all the time! 

If you client is a small company or wholly overseas – you are responsible for deciding yourself if you are inside or outside IR35.  You are obligated to take “reasonable care” in compliance with the rules and are liable for underpaid tax/NIC and significant penalties if you get things wrong. You therefore need a good understanding of where your working practices place you, and should ensure your written contract wholly supports your position.

As you can see, there is a lot to consider and non-compliance with today’s IR35 / off-payroll rules can have significant implications and liabilities for contractors, engagers and agencies, and potentially any other parties within the contractual chain.

If in doubt, it is always advisable to seek the advice of a specialist who can comprehensively review your personal circumstances and contracts, to ensure that you, or the relevant party, has taken reasonable care and that your risks are mitigated as far as possible. This serves to provide protection and peace of mind for all parties involved.

 Are you a hirer of Contractors? Check out our quick IR35 Guide for engagers here.