What is IR35 and what does it mean for contractors?
Self-employed contractors working through a limited company can benefit from tax advantages, but IR35 rules change the way this can be done lawfully. IR35 seeks to make sure that contractors working in the same way as permanent full-time or part-time employees pay the same tax and National Insurance as an employee to crack down on tax avoidance.
IR35 continues to make the news, with significant changes introduced in recent years. It remains a hot topic for the self-employed, with those falling inside IR35 subject to different tax rules.
In this guide, we’ll answer some of the most frequently asked questions about IR35, including:
- What is IR35?
- How does IR35 work?
- Who does IR35 affect?
We’ll also look at how the latest changes could impact contractors and limited companies.
What is IR35?
Also known as the ‘Intermediaries Legislation’, IR35 is defined as off-payroll working by HMRC . IR35 is shorthand for the UK tax legislation that is designed to identify contractors and businesses which are avoiding paying the appropriate tax by working as ‘disguised’ employees. Or those engaging workers on a self-employed basis to ‘disguise’ their true employment status.
IR35 was introduced in April 2000. It takes its name from the original press release published by Inland Revenue (now HMRC) announcing its creation.
IR35 and working as a contractor
IR35 rules are closely wedded to contracting work. If you work as a contractor through a limited company, you can pay corporation tax at 19% on profits under £50,000 . You can also claim business costs against your tax bill and avoid making National Insurance Contributions (NIC) by paying yourself through dividends.
As a result, working as a contractor is often a more tax-efficient set-up than working via an umbrella company or as an employee of a company. Many contractors who are, in reality, operating in the same way as employees are intentionally or unintentionally gaining a tax advantage over others working in the same way as them.
The government has said that it wants to use IR35 to remove this unfair advantage, and at the same time increase its overall tax revenue. That means IR35 could have significant consequences for limited company owners.
Following reforms in April 2021 , it is now the client’s responsibility to determine the IR35 status of contractors in both the public and private sectors. The exceptions are small businesses in the private sector. In these cases, contractors are responsible for working out their IR35 tax status.
What does inside IR35 mean?
To be operating ‘inside IR35’ means that, under the IR35 legislation, you must pay the same tax as an employee. This could also mean that you are entitled to additional rights as an employee or worker (e.g. minimum wage, maternity pay, protection from discrimination).
If you’re found to be working inside IR35, you will usually have to pay a ‘deemed payment’ of income tax at the end of the tax year to account for any tax deductions or NIC that an employee would have paid.
What does outside IR35 mean?
To be operating ‘outside IR35’ means that the IR35 legislation does not prevent you from paying tax on the private contractor basis described above. This means you can pay yourself a salary and withdraw further income as dividends (which are not subject to NIC). Meanwhile, your limited company can pay tax at the 19% corporate rate if your profits are under £50,000.
Things that indicate you are outside IR35 and are operating like a business include having your own business insurance, marketing yourself via a professional website, owning your own equipment and working for multiple clients.
As a contractor, you should consider getting detailed advice on your IR35 status. An IR35 assessment could review both your service contracts and day-to-day working practices.
What do the latest IR35 changes mean?
April 2021 saw a major shake-up of the IR35 rules, which remains in place today. The aim was to align different processes in the public and private sectors.
These IR35 changes were originally expected to be implemented in April 2020. However, due to the Covid-19 pandemic, the government announced an IR35 delay. Instead, the new IR35 regulations were deferred a year, to 6 April 2021. So, what do they now mean in practice?
Key IR35 changes explained
When IR35 first came into force in 2000, each contractor was responsible for assessing their own IR35 status. It was also the individual’s limited company or agency who was responsible for accounting for any tax and National Insurance due where IR35 was applicable.
The rules then changed in 2017 for the public sector. This meant that the responsibility for ensuring IR35 was correctly implemented shifted from the contractor to the public sector body engaging them. However, responsibility remained with the contractor in the private sector.
The IR35 changes of April 2021 aimed to make things more uniform between the public and private spheres. The responsibility for setting IR35 status and paying relevant tax passed from contractors to the private sector businesses engaging them – like in the public sector. It also made the engaging businesses liable should HMRC decide a status had been incorrectly assessed.
These latest IR35 tax changes in the private sector exclude small businesses, however. So, contractors working for small business clients continue to set their own IR35 status.
The Companies Act 2006 defines a small business as a business with two or more of the following features:
- Turnover of £10.2m or less
- A balance sheet total of £5.1m or less
- 50 employees or fewer.
Who is liable for IR35?
Since April 2021, end clients have been responsible for determining their contractors’ IR35 status in both the public and private sectors. They must also ensure the correct income tax and NIC are paid if it’s decided the contractor is operating inside IR35.
Contractors are now only responsible for determining their own status if they operate in the private sector and work for a client that’s classed as a small business .
Clients send a document called the Status Determination Statement to inform contractors of their decision. If a contractor is inside IR35 and contracted directly, the client then becomes their deemed employer. This gives them responsibility for:
- Income tax deductions
- Employee NIC deductions
- Payment of employer NIC
- The Apprenticeship Levy.
If a contractor is working outside IR35 and HMRC has reason to question this, it may open an IR35 enquiry. HMRC can investigate your arrangements at any time, which has the potential to be time-consuming, costly and stressful. This may include a review of tax returns from the previous year. It could also go back up to six years if careless or negligent behaviour is suspected .
If HMRC decides the evidence is not satisfactory, it will conduct an in-depth review of written contracts and working practices. From this, it will make a final decision on the status of the contract. Penalties can apply to both parties if HMRC ultimately decides a contractor is inside IR35.
Does IR35 apply to limited companies?
IR35 could affect you as a contractor if you work for your own limited company. In this case, you’ll need to understand how the legislation works and apply best practice. This means you must meet HMRC’s definition of self-employment by making sure:
- Your work is project-based
- You are not managed by anyone client-side
- You haven’t offered exclusivity to any clients
- You have contracts linked to completion of services, as opposed to a continuous relationship.
If your contract is deemed to be inside IR35, it is possible to continue working through a limited company. Your client will have to deduct income tax and NIC for this contract.
Contractor take-home pay outside IR35 could prove significantly higher than inside IR35. Contractors outside of the legislation can benefit from reduced NIC by taking the bulk of their income in dividends (as it stands, you can earn up to £1,000 in dividends before you pay any income tax on them ). Inside IR35, your income is subject to the same level of taxation as a normal employee. There are IR35 calculator tools available to assess the impact the legislation has on your net income.
Can IR35 impact an umbrella company or sole trader?
IR35 is unlikely to apply when you work through an umbrella company. This is a limited company that employs contractors and acts as a third-party supplier between the contractor and the client.
In this instance, you don’t normally need to worry about IR35 as you’re already paid through the PAYE system and work under a contract of employment with the umbrella company.
IR35 doesn’t apply to sole traders either, but rules for determining employment status do. This means that if the contractor is registered as self-employed but is found to be working as an employee, the end client will be responsible for paying any additional tax due.
While the contractor holds no liability for their employment status, they may still experience a deduction in earnings as they will have to be placed on the payroll of the company.
The following is a non-exhaustive IR35 compliance checklist of some of the factors that can indicate whether you are inside or outside IR35. As noted above, you should consider getting detailed advice on your IR35 status involving a review of both your service contracts and day-to-day working practices.
Here are some of the factors that could leave you inside IR35:
- You carry out all of the work that your company is contracted to do personally
- You work for your own limited company, but receive employment benefits such as paid leave or sick pay
- You are being paid on a time basis
- You have close supervision by somebody in your client’s business
- You are supplied with the equipment by a client and work at their premises
- You work for one client long-term
- All rejected work is corrected at your client’s cost
- You do not have your own business identity.
Here are some common features of those falling outside IR35:
- You have the right to delegate or substitute work contracted to another person and that right is exercised in practice
- You work for your own limited company and do not receive employment benefits such as paid leave or sick pay
- Being paid on a project basis or at a fixed price
- You have the right to decide how and when you work and can send a substitute to do the job if you please
- You supply the appropriate equipment and may work from your own premises
- You work with more than one client at one time or on short successive projects with a variety of clients
- All rejected work is to be corrected at your own cost
- You have your own premises, insurance and branding.
IR35 meaning – frequently asked questions
Will IR35 be scrapped in 2023?
No, the IR35 regulations for the self-employed will not be scrapped in 2023. Former chancellor Kwasi Kwarteng had moved to repeal the IR35 rule changes of 2017 and 2021. However, current chancellor Jeremy Hunt later decided against this course of action . As a result, the IR35 system remains in place.
How do I know if IR35 applies to me?
Following the 2021 rule changes, your larger clients will generally be responsible for deciding whether IR35 applies to you. The exact definition isn’t clear-cut. But they’ll normally review whether your relationship is the same as if you were a formal employee .
Can I dispute an IR35 decision?
Yes, contractors can formally disagree with the IR35 status that a client gives them. It’s possible to raise a disagreement until your final payment. The client needs to give you a response within 45 days.
*Disclaimer: At Hiscox, we want to help your small business thrive. Our blog has many articles you may find relevant and useful as your business grows. But these articles aren’t professional advice. So, to find out more on a subject we cover here, please seek professional assistance.
At Hiscox, we want to help your small business thrive. Our blog has many articles you may find relevant and useful as your business grows. But these articles aren’t professional advice. So, to find out more on a subject we cover here, please seek professional assistance.