IR35

What is Ir35 and How Will it Affect Me?

IR35 is every contractor’s worst nightmare! It is a piece of legislation that is universally hated by everyone in the contracting sector and it has been since its introduction in 1999. But for anyone new to contracting what is it and what does it do? In a nutshell, IR35 gives HMRC the power to change the tax status of contractors from limited company contractors to regular employees (for tax purposes) if it thinks they are gaming the system. Obviously, for anyone this happens to it can be a massive shock and have a seriously negative effect on their contracting income. Why does HMRC do this? Blame the 90’s! The legislations whole purpose is to try and combat what HMRC describes as ‘disguised employment.’ In the 1990’s it was a popular tax strategy for highly paid company employees to cut their tax bill by changing their job description to ‘consultant’, quitting their employment and then claiming to be

The legislations whole purpose is to try and combat what HMRC describes as ‘disguised employment.’ In the 1990’s it was a popular tax strategy for highly paid company employees to cut their tax bill by changing their job description to ‘consultant’, quitting their employment and then claiming to be self-employed, all the while working for their old companies still. IR35 was brought in to eradicate this practice, which it mostly did, but unfortunately, it also caught a lot of innocent contractors in its very wide nets.

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What Is The Financial Impact Of IR35?

Well, it’s not fun. Any contractor who finds themselves falling into IR35 will immediately see their take home pay plummet by up to 24%. That’s because they will not only pay higher tax and NIC’s but also they will not be able to take advantage of the usual allowances and expenses that they can use when working for their limited companies.

How Do I Know If I Am Inside IR35?

This is one of the chief grievances of most contractors. It is not always that easy to determine if you are likely to be caught up in the IR35 trap. However, there are certain common mistakes and situations that will normally cause a contract to sit within the IR35 framework:

Control

– This is the main issue and the first thing HMRC look for. As a contractor, you need to ensure that you are choosing your own place of work and your own hours and the method that you use to do your work. If a contract requires you to work set hours on set days, or simply requires you to work when the client asks you to work, then you are seriously risking being within IR35. – More Information

Obligation

– You should also ensure that there is no mutuality of obligation. What is mutuality of obligation? It is what you get with an employment contract. Under employment contracts, employers are obliged to provide employees with work and employees are obliged to do that work. If a mutuality of obligation then you will almost certainly fall within IR35.

Substitution

– The contract should contain a right of substitution. If the contract names you as the sole individual to do the work then it is more likely to fall within IR35. On the other hand if it contains a clause that substitution is allowed (and another contractor can complete the work) then it is more obvious that a service is being paid for, not an employee.

What Can I Do To Ensure I Stay Outside IR35?

The most important thing you can do to avoid IR35 is make sure the contract is drafted extremely carefully. The contract needs to make crystal clear that the client will be paying for specific tasks and should include a schedule of works. As mentioned above it should contain no mutuality of obligation and should contain a right to substitution. There should be no mention of regular working hours and no mention of supervision or direction.

Why does it cause so many problems? This page will hopefully answer that, and offer some solutions too, covering everything you need to know about the dreaded IR35.

What are the IR35 Factors?

IR35 Factor Name
Control & Direction
Substitution
Mutuality of Obligation
Provision of Equipment
Financial Risk
Basis of Payment
Part & Parcel
Exclusive Service
Intention of the Parties
In Business On Your Own Account

Ok, Let’s Get Started – What Is This IR35 All About Then?

The ir35 legislation was introduced in April 2000 and was intended to provide a way of determining if contractors who were operating from within a limited company structure were working for themselves or could actually be deemed as employees of one particular client. This was brought in because HMRC and the government had noticed that there were often circumstances in which contractors were able to offer their services to one client (through limited company or partnership) and effectively be their employee, but not have to pay the regular National Insurance contributions and PAYE tax. By doing this they could save themselves a lot of money by simply choosing to be paid through the dividends and corporation tax of their companies, which would be a lot lower. Because HMRC saw this situation occurring more and more, they responded with IR35.

The whole point of IR35 is to spot those cases where a worker is employed as a contractor for the purposes of tax in a situation where they would normally be considered to be a regular employee of their client or client company. In such instances, they would also therefore be considered as an employee for tax and national insurance purposes and are therefore avoiding paying tax and NIC’s. To take an obvious example, imagine if someone works for a large company and then quits their job one Friday evening. Now imagine they return to work for that company on Monday morning as an independent contractor working for their own limited company. They still do the same work, solely for the one business, working the same hours for the same people doing the same type of job and are consequently as involved with the company as they were before.
Now, this might seem like an extreme example and would obviously be caught very quickly by IR35 legislation. But for most contractors, the problems come in cases which aren’t so obvious. Whilst it is extremely useful for a contractor to work for their own limited company they can only reap the advantages if their contracts fall outside of the IR35 legislation. And whilst most people would think it easy to draw clear lines between inside and outside of IR35, for HMRC it is not so simple. This is where the problems start.

How Is IR35 Status Determined Then?

Not as easily as you would expect. This is an important point to bear in mind for new contractors as you don’t want to get a nasty shock later. When weighing up your own contract status, don’t just assume because you have your own limited company and no permanent employment that you will be clear of IR35 infringements. HMRC have, over the years, proven themselves more and more determined to catch out even the slightest IR35 lapse and to try to move as many contracts as possible over to PAYE. So you need to know what they are looking for and make sure you keep it in mind with every contract that you take on.

What are the main things they look for? When HMRC looks at a contract the basic question they will ask is whether this contractor and their limited company are experiencing the same issues as other contractors working in similar roles for limited companies. And they do this by assessing 4 things – whether you are experiencing the same risks, responsibilities and liabilities and whether you have the same level of control. These 4 areas – control, responsibility, risk and liability – are what you need to consider each and every time you start a new contract because it is these 4 areas that HMRC will use to decide if you are a regular contractor or if you are what they term as a ‘false employee.’ In order to understand them, we will have a look at each of them (and a couple of other issues) in more depth below by asking the most pertinent questions:

Do I Have Control?

The first and most important question to be asked is whether you have control over the services you offer and if so, how much control. This won’t always be completely obvious but the main thing that HMRC will want to see is that whatever work you do for a client, you still have the appropriate level of control whilst doing your job. This means that you are always in charge of the services you offer and the services you perform, the place you perform them, the time that you perform them and the manner in which you do it. Let’s take the example of an IT contractor who has been contracted to install a firewall for a company’s website. If the IT contractor is told to come in on a Monday morning and sit down and write the firewall then they are not in control. On the other hand, if they say to the company that they can’t do Monday morning but could come in Thursday evening , then they have maintained a certain level of control over their own services. This is a simplistic example but is illustrative of the main point. In the first example they are more like an employee of the company and in the second example they are much more like a freelancer or contractor. It will obviously not always be so clear-cut and contractors often need to hand some control over to their clients so they can work well together but that control should be about the fine details of the service being offered and not about the provision of that service. You should always have control of your own way of conducting your work and the mode of your work and should not let the client dictate anything to do with the provision. Over the last few years there have developed a number of control markers which can help you and which you should avoid where possible when looking at a contract. Firstly, try to avoid having start and finish times each day. Secondly, try to avoid being allocated specific days for you to work the contract. Thirdly, avoid specified lunch breaks and especially avoid a set period of time for those lunch breaks! And finally, avoid at all costs the express mention of any type of supervision or control coming from the client to the contractor. If one party is telling the other party what to do and how to do it then that looks too much like an employer talking to an employee. The more it appears to be a simple transaction with one person providing services for another, the better.

Am I Vulnerable To Financial Risk?

Another tell-tale sign that you are not within IR35 is that you are taking on the right amount of financial risk. The way to judge this one is to be able to show that you and your company are taking on the same levels of financial risk as other company director contractors operating in a similar fashion to you. If you were working as an employee (or ‘false employee’) of a company you would be under no financial risk, whereas company directors take on a lot of risks – unpaid invoices, damaged equipment, lawsuits etc – and are therefore clearly distinguishable. If a contractor was to work for one company through their limited company and effectively receive a constant and regular monthly salary with no risk then that would most likely be enough to push that contractor into IR35.

Do I Get Any Employee Benefits?

Here’s the thing – if you do get any employee benefits, then you will almost certainly be falling within IR35. In order to be seen as a sole contractor and a legitimate director of a limited company then it is absolutely essential that you never receive any employee benefits of any kind from a company you are contracting for. Not a single one! This means that you cant accept any of the following as perks from any of your clients – sick pay, holiday pay, maternity pay, training courses, equipment training, employee parking and employee gym membership. The list goes on. If it is a company perk then you need to steer clear of it.

Do I Own The Equipment Needed To Work The Contract?

If you don’t, you should make sure that you do. HMRC will almost certainly look closely at equipment ownership when evaluating IR35 status. HMRC consider who owns the equipment to be another risk marker for contractors; if the contractor brings their own equipment to a job then they are the ones taking the risk by buying, owning and using their own assets. This could be tools for building, ladders for painting, computers for writing code or web pages, engineering equipment for taking readings or anything else. The point is, ownership shows commitment to their own company and a willingness to take on assets. Employees, on the other hand, expect their firms to provide them with any equipment they need to do their work. Consequently, if a contract offers to provide the tools, be they ladders or laptops, bear in mind that HMRC would consider that a strong sign of being within IR35.

Can I Be Fired?

Another important factor is the presence or absence of a working obligation between client and contractor. Does the client or you have the right to dismiss one another at short notice? If so, then you are probably ok, but if there is a required fixed notice period for dismissal then you are straying into the territory of employer/employee.

Is There An Obligation To Offer / Provide Work?

Similarly, HMRC would consider your contract to be within IR35 if it deemed there to be an obligation on you to have to take any and all work sent your way by a client or conversely an obligation on the client to keep providing you with work. For HMRC that relationship would once again be too much like employee and employer for their liking.

Is It Worth Inserting A Substitution Clause?

Absolutely yes. Though a contract lacking a substitution clause won’t immediately push you into IR35, a contract with one will certainly help you to stay out of it! The presence of a clause in a contract that states your company is providing a service and that if you are not able to fulfil it then someone else will is a sure sign that you are not employed by your client. Clearly, companies can’t simply swap one employee for another, whereas contractors can if necessary. However, a clause like this shouldn’t cause your clients to worry that you won’t be around to do the work, it is just there to ensure you could get cover if something unforeseen does come along and to keep you out of IR35!

Ok, With All That In Mind, What Happens If I Do Get Caught By IR35?

You’ll quickly learn the full implications of the HMRC phrase ‘deemed salary.’ This means that any money which you had been earning (or will earn in future) on your now IR35 applicable contract is now deemed to be a salary and is therefore liable for tax and NIC’s at a standard rate. At the same time, you will no longer qualify for all your usual limited company expenses on that contract. And lastly, they will then also want to investigate all of your other previous contracts to check for any other infringements. This could, obviously, lead to a very large tax bill.

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