What is IR35?

Whether you’re new to contracting or you’ve been self-employed for some time, IR35 can be difficult to understand. As a complex piece of legislation, its nuances can often cause a great deal of confusion.

Our guide is here to help you understand what IR35 is, why it was introduced and what the updates to the public and private sector have meant for contractors.

What is IR35?

IR35 is a tax legislation which was designed to combat disguised employment amongst the self-employed. In short, IR35 comes down to one crucial factor: are you in an employment relationship with the end user of your services or is it a genuine business-to-business relationship?

The IR35 legislation aims to ensure that those in ‘disguised employment’ pay the correct amount of tax. Each assignment is considered separately for IR35 purposes, and so if you are working as a self-employed contractor on an assignment which is deemed outside of the IR35 legislation, you can take advantage of the tax efficiencies associated with working through a limited company.

If after an IR35 assessment, your role is classed as disguised employment, you’ll be deemed inside IR35 – meaning you’ll need to pay Income Tax and National Insurance on your earnings in the same way as an employee would.

IR35 in the public sector

The reforms to off-payroll working were first introduced in the public sector on 6th April 2017. As an overview, the reforms saw responsibility for determining the IR35 status of an assignment shift from the contractor to the end hirer.

Find out more about these changes in our guide to IR35 in the public sector.

IR35 in the private sector

Although closely following the public sector reforms, some key distinctions were announced with the private sector IR35 reforms, effective as of the 6th April 2021:

The small companies exemption

The off-payroll reforms do not apply to assignments where the end-user is a small company as defined by the Companies Act. This means that contractors engaging with a small private sector company will still determine their own IR35 status. The Companies Act defines a company as ‘small’ and therefore exempt from the IR35 reform if they meet two of the following criteria:

Annual turnover doesn’t exceed £10.2m
Balance sheet total doesn’t exceed £5.1m
No more than 50 employees

In this situation, if you are the fee-paying agency placing contractors into ‘small’ companies, the contractor will continue to set their IR35 status and carry the liability.

5% expense allowance

As was the case in the public sector reforms, the private sector reforms meant the 5% expenses allowance, which HMRC allowed contractors operating inside IR35, was removed. This allowance was initially introduced to help contractors cover the expenses of administering IR35 and calculating the ‘deemed payment.’ However, given the new responsibilities on the end-hirer to determine the IR35 status of the contract and the fee-payer to make deductions for tax and National Insurance, the government has scrapped it.

Should the contractor work inside IR35 with a ‘small’ company in the private sector, this allowance will still apply.

Introduction of the Status Determination Statement (SDS)

When making IR35 decisions, private sector companies are required to share their reasons for a particular determination with the contractor and the first recruitment agency in the supply chain. This must then be passed down the chain until it reaches the ‘fee-payer’.

HMRC calls this a Status Determination Statement (SDS) and introduced it with the aim of increasing transparency with regards to assessments. Until the client shares this with the contractor and the fee-payer, they will carry the liability and therefore the risk.

The client must demonstrate that they have taken ‘reasonable care’ when undertaking the Status Determination Statement. If reasonable care has not been taken, they will assume the role of the fee-payer if the contract is found to be inside IR35.

What is reasonable care?

Whilst initially ambiguous and at the discretion of the end client to determine, HMRC revised the definition of reasonable care following an influx of criticism. HMRC’s Employment Status Manual outlined the ways it can be shown. Some examples include:

Applying HMRC’s IR35 determining criteria
Accurately completing HMRC’s CEST tool
Seeking the help of a professional advisor

The transfer of debt provision

The IR35 private sector reform introduced a new power for HMRC to collect PAYE earnings that goes unpaid from other parties in the supply chain. This means that if the fee-payer fails to make deductions and pay the PAYE tax and National Insurance liability, HMRC can recover the unpaid liability from other organisations in the supply chain on all contracts in both the public and private sector from April 2021.

Can IR35 be applied retrospectively?

HMRC confirmed in the run-up to the private sector reforms that a change in IR35 status, moving from outside IR35 prior to the reforms to inside IR35 post reforms will not in itself trigger an investigation. However, some have interpreted this as HMRC not opening any new investigations into contractors, which is not the case. HMRC can, and will, continue to open IR35 investigations.

How far back can HMRC investigate?

Minor, unintentional errors may see HMRC investigating contractors and their assignments up to 4 years retrospectively, which increases to 6 years if HMRC can prove carelessness. HMRC will only reexamine an account spanning back 20 years if they suspect fraud or criminal activity.

It’s crucial to remember that the worker holds all liability resulting from non-compliance for assignments and income received before the 6th April 2021, which hails the reforms.

Any liability arising after this date will be the responsibility of the ‘fee-payer’ - usually a recruitment agency or the end-hirer if they failed to exercise reasonable care or provide a Status Determination Statement.

Many contractors and industry commentators have raised concerns that HMRC may use a change in employment status as the catalyst to start an investigation. Particularly as we see private sector organisations taking a risk-averse approach to the reforms and applying blanket determinations to contractors. However, HMRC has iterated that they will only pursue this course of action should they uncover fraudulent or criminal activity.

Retrospective investigations and enquiries are not the intention of HMRC, but mitigating factors such as those we have mentioned above will always warrant a closer inspection by the body.

Does IR35 impact umbrella company employees?

No. If you’re an umbrella worker the good news is that IR35 doesn’t apply. The legislation only comes into play for self-employed contractors operating through their own Personal Service Company (PSC) or partnership, so there’s no need to worry.

How does IR35 affect limited company contractors?

Given the IR35 implications for contractors are dramatic – effectively determining if you pay employment taxes (inside IR35) or should be classed as self-employed for tax purposes (outside IR35) – you must be confident of your compliance.

If you work via your own limited company and want to learn more about how IR35 affects contractors like you, our sister company, Caroola, has an essential IR35 guide, which should prove useful.