The Implications of Being Inside IR35

IR35 legislation is notoriously complex and many factors should be considered when determining if a contract belongs inside or outside these tax rules.

Given the potential cost of non-compliance, it’s crucial that contractors, recruitment agencies, and end clients understand precisely what it means to work inside or outside IR35.

In this guide, we focus on the implications of working inside IR35.

What does inside IR35 mean?

When a contractor’s assignment is considered inside IR35, this means that, for all intents and purposes, they provide their services in a manner that reflects employment.

As a result, contractors working inside IR35 are classed as ‘employed for tax purposes’, meaning they are taxed under PAYE, just like employees.

Are umbrella company employees inside IR35?

No. Umbrella company employees are engaged under a contract of employment and are, therefore, legally speaking, employees of the umbrella company. As we’ll go on to explain, IR35 is not a consideration.

Working through an umbrella company inside IR35

This is something we’re often asked about at Parasol. However, working through an umbrella company inside IR35 isn’t relevant because the IR35 legislation is only a consideration for people operating via personal service companies.

As employees, the IR35 rules do not apply to umbrella company workers, which is one of the (many) benefits of working this way.

Who decides if a contract is inside IR35?

The UK Government introduced the IR35 legislation in 2000, and until 2017, contractors were responsible for determining their IR35 status in all situations. However, the IR35 reform changed this.

Rolled out in the public sector in 2017 and the private sector in 2021, the changes mean the end client is now tasked with assessing IR35 status – unless the end client qualifies as a ‘small company’, which means the contractor is still responsible for determining it.

Status Determination Statements (SDS)

When an end client has determined IR35 status, they are legally required to provide the contractor with a Status Determination Statement (SDS). This is a document confirming the outcome of the IR35 assessment, along with the reasons that led to this decision.

The implications of being inside IR35

As mentioned earlier, the implication of a contractor’s assignment being inside IR35 is that they will be taxed at a similar rate to a regular PAYE employee.

This means the contractor will pay National Insurance Contributions (NICs) and Income Tax as if they are an employee. As a result, inside IR35 contractors do not receive the usual tax benefits of working through a limited company, due to the contract reflecting an employment relationship.

If the IR35 contract review and the end client indicate that the assignment is inside IR35, the fee payer – which is the organisation that pays the Personal Service Company (PSC) – will be responsible for the following:

Making PAYE RTI submissions to HMRC
Deducting PAYE tax
Deducting National Insurance
Paying employers' National Insurance Contributions

This is why most agencies will prefer a contractor working on an inside IR35 assignment to work through an umbrella company, instead of their own PSC, as they know that the correct tax and NI will be deducted.

Expenses whilst working inside IR35

The expenses that contractors working inside IR35 can claim were limited even before the introduction of IR35 reform.

However, since end clients became responsible for determining IR35, the ‘5% expenses allowance’ that limited company contractors were granted, to cover the overheads of their company, when calculating how much tax they should pay on an inside IR35 engagement, has been removed (unless a small company engages the contractor).

This is because the IR35 reform seeks to treat all inside IR35 assignment workers as employees for tax purposes, and generally, employees would not benefit from such expenses relief. Working out how much tax is owed on an inside IR35 contract and ensuring that this is paid over correctly to HMRC, lies with the fee-paying party, rather than the contractor.

Importantly, inside IR35 contractors can claim tax relief on pension contributions made via their personal service company.

How to challenge an inside IR35 determination Speak to the end hirer

The government recommend following the client-led disagreement process, should a contractor disagree with an IR35 determination made by the end client.

Under this, the contractor should write to the end client to challenge the IR35 determination (referencing the reasons stated in the SDS). The end client must respond within 45 days of the challenge with a new SDS or state the factors why the initial SDS is correct.

When challenging an inside IR35 determination, contractors often have their contracts reviewed by a specialist. The insight of an independent and objective expert could prove decisive in supporting any argument that a contract belongs outside IR35, rather than inside.

Contact an IR35 specialist

In addition to Parasol’s significant in-house expertise, we have partnered with Qdos to provide an extensive and reliable IR35 review. Together we have vast experience, industry knowledge and can be relied upon for trusted advice.

If a contract has been reviewed expertly and the assignment is deemed inside IR35, all parties may opt to engage an umbrella company for the contractor to operate through. It means, that rather than working as an employee for tax purposes, the contractor can become an umbrella company employee and receive full employment rights and protections.

Umbrella company employees do not have the administration associated with running a business, with Parasol making PAYE deductions for tax and NI contributions, as the employer.

Want the best of both worlds?

Recognising the challenges that IR35 poses to contractors and recruitment agencies, Parasol offers a dual solution that allows contractors to switch seamlessly between umbrella and limited company working, depending on the nature of the assignment.