The IR35 legislation is a tax rule that individuals operating via their own limited company, irrespective of industry, need to be aware of.
IR35 determines whether or not freelancers and contractors are deemed genuinely self-employed or what’s known as disguised employees. As you may know, the IR35 legislation is complex and often misunderstood. So in this article, we’ll explain what IR35 is, what it means to work ‘inside’ or ‘outside’ IR35 and more.
What is IR35 tax legislation?
IR35 exists to prevent limited company contractors from working as disguised employees. Disguised employment occurs when an individual providing their services via their limited company (also known as a personal service company) does so in a manner that reflects employment. HMRC’s view is that if a working relationship reflects employment, the worker should be taxed as an employee. This was the government’s reasoning for introducing the IR35 legislation in 2000 – to prevent contractors (whose engagements reflected employment) from avoiding employment taxes.
What’s the difference between outside and inside IR35?
When engaged by a client, a contractor will be classed as either ‘inside’ or ‘outside’ IR35. To be inside IR35 means the relationship between the contractor and end-client reflects employment. Contractors operating inside IR35 are deemed ‘employed for tax purposes’, meaning that income for that assignment, contract or project is subject to PAYE tax – just like an employee’s.
To be outside IR35 means that the contractor provides their services to the end-client as a genuine business – this is often referred to as a contract for services, as opposed to a contract of service. The nature of an outside IR35 relationship is no different than, say, any other business providing its services to a client. When working outside IR35, income for that project isn’t subject to PAYE tax.
Who do the rules apply to?
This is where things can get complicated, given there are many different factors to consider when determining if a contract belongs inside or outside IR35. The three key IR35 status tests are:
- Control – this assesses if the end-client controls the working relationship in the way that they would for an employee. If the worker has little control or autonomy over how they deliver their services, the contract may fall inside IR35.
- Personal service – is the service provided delivered personally, by Joe Bloggs of Joe Bloggs Limited? Or could any qualified individual working for that business carry out the work? If personal service is provided – one that the success of the project relies upon – there’s a chance the engagement could be deemed inside IR35. Alternatively, if a contractor can substitute in another contractor, the service is less likely to be personal.
- Mutuality of Obligation – MOO, as its known, weighs up if there’s a mutual obligation for the end-client to provide paid work to the contractor and for the contractor to accept this. Employees, for instance, are mutually obliged to work for their employer. Contractors, as business owners independent from their clients, should not be in theory.
These are just three examples of the factors that contribute to an IR35 determination. There are many more – from whether the contractor shoulders financial risk (i.e. is responsible for fixing mistakes at their own cost) to whether they are ‘part and parcel’ of the end-client’s organisation.
How is IR35 regulated?
IR35 has evolved since its arrival in 2000, to the point where end-clients are now responsible for determining if a contractor belongs inside or outside IR35 – that is, unless, the end-client qualifies as a ‘small company’ under the Small Companies Act 2006. If this is the case, the risk and responsibility to correctly assess their IR35 status remains with the contractor. HMRC polices IR35 compliance among businesses, but also contractors.
Following the introduction of the ‘off-payroll working rules’ in the public and private sectors (which saw end-clients handed the responsibility for determining IR35 status), businesses are liable for mistakes. However, HMRC can still launch IR35 investigations into contracts held and completed prior to the roll-out of these rules – when contractors held the IR35 liability.
If, say, a contractor is found to have been incorrectly working outside IR35 (pre-2017 in the public sector and pre-2021 in the private sector) they may be issued with a retrospective tax bill (plus interest and possibly penalties) for income tax and national insurance contributions.
How does it affect me?
IR35 is a consideration for all individuals providing their services to clients via a limited company – regardless of whether they identify as a freelancer, contractor or consultant. Given the financial implications of operating inside or outside IR35, it’s vital that independent workers are confident of their compliance with these regulations.
