IR35, also known as off-payroll working rules, is tax legislation introduced to ensure that contractors who work in the same way as employees, pay the correct amount of tax.
There has been a lot of talk about IR35 recently and you may well have seen more on these tax rules in the news. In his mini-budget on 23 September 2022, the then Chancellor Kwasi Kwarteng proposed changes to the off-payroll working rules. But, on 17 October 2022, the new Chancellor, Jeremy Hunt, scrapped these plans as part of a wider U-turn on government policy.
At the time of writing, off-payroll working rules that apply to contractors remain in place and unchanged. Here, we explain how the law works and whether it applies to you.
What is IR35?
IR35 refers to UK tax legislation originally introduced in April 2000, which is designed to make sure contractors pay the right amount of income tax and National Insurance contributions (NICs).
The IR35 rules apply specifically to workers who are effectively working as employees but have registered as a limited company to provide a service. This may give the impression they are self-employed and can therefore pay less tax.
For example, a contractor might set up a limited company, or other intermediary, through which they can provide a service to a client. The client would pay the company, which is often referred to as a ‘personal service company’, or PSC, for any work done, and the contractor could then pay themselves through dividends from the PSC.
By working as a contractor in this way, an individual could potentially avoid paying income tax and NICs that they would have to pay if they were an employee. In addition, their client may avoid paying employers’ NICs and providing employee benefits, such as holiday allowance and sick pay, which they would be required to pay if they directly employed the contractor.
These off-payroll working rules aim to crack down on the tax avoidance that can result from contractors working in this way. Those found to be ‘inside IR35’ by HM Revenue & Customs (HMRC) must pay tax and NICs as an employee, regardless of the way their contract is set up.
What does inside IR35 mean?
If you are ‘inside IR35’ it means that you are classified as an employee for tax purposes and are subject to Pay As You Earn (PAYE).
If they hire contractors inside IR35, the employer must also match the NICs these contractors pay to the government.
You can find more information on what you need to pay if you’re inside IR35, as well as how to pay, at Gov.uk.
» MORE: How the PAYE system works
What does outside IR35 mean?
If you are ‘outside IR35’, it means that you are not considered an employee of the client using your services. HMRC sees you as genuinely self-employed, and you will be responsible for paying the right amount of tax by completing a self-assessment tax return each year.
How do I know whether I’m inside IR35?
A number of factors influence whether an individual is inside or outside IR35, including:
- the rights they have at work
- the control they have over their work
- whether they can send a substitute to do their work
- whether there is mutuality of obligation between the contractor and the client
HMRC offers a check employment status for tax service to help you find out whether the IR35 rules apply to you, based on the information provided.
You’re likely to be inside IR35 if you receive the same rights as a permanent employee. This includes, but isn’t limited to, annual leave entitlement, sick pay, employee benefits or membership schemes.
Whether you’re inside IR35 rules also depends on the amount of control you have over your work.
If you can’t control what you work on, or how, when and where you complete your work, you may find yourself inside IR35. This is because you’re essentially acting like an employee, where a company dictates your work, your workplace and how you’re expected to work.
On the contrary, if you have control over how you work, you may be outside IR35. For example, this may be the case if you are able to pick a time and place in which to complete your work.
A key tenet of IR35 is substitution – whether or not you can send someone else in your place to complete the work you’ve been asked to complete.
If the contract for your work does not allow you to send anyone else in your place, you may fall inside IR35 rules as this is similar to being employed.
On the other hand, if you are able to send a replacement to do your work, then you may be outside IR35.
Mutuality of obligation
Mutuality of obligation (MOO) is one of the tests used to work out whether an individual should be classed as an employee or a contractor.
MOO relates to whether a client is obliged to offer you work, and whether you are obliged to accept it.
For example, if a client is obliged to offer you more work and you are automatically expected to take up future contracts, then you may fall inside IR35. This is because it suggests key elements of an employment contract, where an individual could reasonably expect more work in future and the client could expect only the individual to complete it (rather than someone sending a substitute).
Who do the IR35 rules apply to?
The IR35 rules apply to workers who are providing their services through an intermediary (such as a PSC) and clients who are receiving services from workers through their intermediary.
Agencies – such as recruitment agencies that provide contractors to clients – may also come under these rules.
Responsibility for deciding whether IR35 applies to the contract depends on the size of the client.
Public authorities and medium- and large-sized clients outside the public sector now bear responsibility for deciding whether contracted workers who provide services through their own intermediary fall inside IR35 or not. Contractors should get an employment status determination from their medium- or large-sized client, as well as the reasoning behind it.
Small business clients are exempt from IR35 rules. In this instance, contractors’ intermediaries must figure out for themselves whether they fall inside or outside IR35 and act accordingly.
If a contractor is using a PSC, this may mean that it is the responsibility of the contractor to work out their employment status for tax purposes.
Who is exempt from IR35?
Small businesses are exempt from IR35 rules. This means that if a small business contracts an individual for work, it is the responsibility of the contractor to check whether they fall inside IR35, not the small business.
A small business is defined as meeting two or more of the following criteria:
- Annual turnover: No more than £10.2 million
- Balance sheet: No more than £5.1 million
- Employees: No more than 50 employees
On the contrary, medium- and large-sized businesses must check whether their contractors fall inside IR35.
Does IR35 only apply to limited companies?
Yes, IR35 only applies to limited companies. It was designed to ensure that people working through an intermediary pay the correct amount of tax.
IR35 aims to target self-employed people who are providing services as a contractor through their own limited company (often referred to as a PSC).
IR35 generally doesn’t apply to umbrella companies – for example, a business that a recruitment agency uses to pay temporary workers – as these will usually use PAYE.
Does IR35 apply to sole traders?
IR35 does not apply to sole traders because they operate as self-employed individuals rather than through a limited company.
It’s important to note that the rules around employment status for tax purposes are similar to IR35. The employment status test for sole traders also looks at an individual’s work arrangements and daily working activities. You can check if you or someone else is self-employed for tax purposes on Gov.uk or by contacting HMRC if you can’t check online.
Do I need to use an IR35 contract review service?
An IR35 contract review service uses an independent tax specialist to analyse a person’s work contract to determine whether they fall inside or outside IR35.
Contractors are not legally obliged to use an IR35 contract review service. It can be expensive, depending on the length of the contract and the tax specialist you hire. However, it could be a good option for self-employed workers with a limited understanding of IR35 rules or who would just like a second opinion to confirm their tax status.
What’s more, if your tax status is later investigated by HMRC, a review could demonstrate that you have taken steps to ensure you are complying with tax regulations.
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