IR35 is a UK tax legislation designed to combat tax avoidance by workers supplying services to clients through an intermediary, such as a personal service company, who would otherwise be considered employees if the intermediary were not used. It ensures that these workers pay similar income tax and National Insurance contributions as regular employees.
Who do IR35 rules apply to?
IR25, also known as off-payroll working rules, affects businesses who work with freelancers or contractors. If you or your business fall under any of the following categories, you might be subject to IR35 rules:
- Workers: Those who deliver services to a client, typically through a limited company or a personal service company (PSC). They may also use a partnership or deliver services through another individual.
- Clients: Those who receive services through an intermediary; also called the hirer, end client, or fee-payer.
- Agencies and other types of suppliers: Those who provide workers with services through intermediaries.
When do the IR35 rules apply?
IR35 has different rules for determining a worker’s employment status for tax purposes depending on whether the client is in the public sector, the private sector, or if it’s a large or small business. Generally, it’s up to the client to determine whether they’re classifying workers correctly and deducting tax accordingly. The rules and tools below can help you apply IR35 if your business works with contractors.
What does it mean to be inside or outside IR35?
Determining whether a worker is inside or outside IR35 means determining their IR35 status—and whether the worker should be treated as an employee for tax purposes or as a self-employed contractor.
What does inside IR35 mean?
If a worker is deemed to be inside IR35, it means they are considered an employee for tax purposes. In this case, the worker’s client or agency must issue a Status Determination Statement (SDS) confirming that the worker is subject to PAYE (Pay As You Earn) tax and National Insurance contributions, similar to a regular employee.
What does outside IR35 mean?
If a worker is outside IR35, it means they are considered genuinely self-employed and operating through their own limited company. The worker is responsible for managing their own taxes and National Insurance contributions.
How to know if you are inside or outside IR35
There are different tools and services available to help determine your IR35 status.
HMRC offers a Check Employment Status for Tax (CEST) tool. Businesses can use the free online CEST tool to assess whether a worker falls inside or outside IR35. They can also seek consultancy from tax professionals or legal consultants who offer IR35 assessments or contract reviews.
Best practices for navigating IR35
Navigating IR35 requires careful planning and understanding of working practices to avoid classifying workers incorrectly. Both businesses and contractors must follow best practices to ensure compliance with the off-payroll working rules.
IR35 tips for businesses
- Assess working arrangements: Make sure that the nature of your working relationship with contractors genuinely reflects self-employment. Regularly review contracts to align with IR35 regulations.
- Issue clear contracts: Draft contracts that clearly distinguish contractors from employees in terms of control and obligations.
- Conduct regular reviews: Implement an IR35 assessment process to regularly review contractors’ status, especially for long-term projects, to avoid misclassification.
- Take reasonable care: When determining a contractor’s status, apply reasonable care and use tools like HMRC’s CEST (Check Employment Status for Tax) to evaluate employment status.
IR35 tips for contractors
- Maintain autonomy: Demonstrate your independence by showing you have control over how and when the work is done. You should avoid working as if you are a disguised employee.
- Use substitution clauses: Your contract should include a clear right to provide a substitute to perform your duties, showing that your services are not reliant solely on you.
- Keep records: Maintain documentation of contracts, invoices, and communications to prove that you operate as a genuine contractor. Proper invoicing procedures are key to demonstrating your independent status.
How businesses or contractors can fail IR35 tests
Businesses are responsible for making sure that all workers they contract with—even indirectly—comply with IR35. That means you can be held liable for a worker who fails an IR35 test at any point in your supply chain. According to case law, there are many different aspects HMRC and the courts might examine to determine whether a worker is a contractor or an employee, including:
- History of the role: If the role was previously filled by an employee, IR35 authorities may classify the current contractor as a disguised employee.
- Content of the work: If the contractor's duties mirror those of regular employees, they may fail the IR35 test.
- Businesses subject to previous investigations: Companies with a history of non-compliance or ongoing investigations may face additional scrutiny of contractor relationships.
- Legitimate contracts: Failure to maintain clear, legally compliant contracts can lead to IR35 issues, especially if contracts don’t align with actual working practices.
- High levels of control: When clients exert too much control over contractors’ work, such as dictating work hours or methods, it could signal employment.
- Substitution of contracting work: If contractors are not allowed to send a substitute in their place, they may be viewed as an employee.
- Equipment: Contractors who use the client’s equipment rather than their own may fail the IR35 test.
- Invoicing procedure: Contractors should issue invoices for work, rather than being paid through payroll, to demonstrate they are truly independent.
- Client-contractor relationship: Contractors should avoid developing an employee-like relationship with the client, such as receiving benefits like pensions or paid leave.
- Evolving under a mutuality of obligation: If there’s an expectation of ongoing work from the client to the contractor, it may suggest an employment relationship.
Penalties for breaching IR35
Failing to comply with IR35 can lead to significant consequences for both businesses and contractors.
In all cases, businesses and contractors are responsible for any outstanding tax liability they didn’t pay, plus National Insurance contributions, pensions, and other unpaid taxes that resulted from the misclassification.
Contractors who choose the wrong status by mistake can be liable for penalties up to 30% of their unpaid tax bill. If they continue to operate as self-employed knowingly, the penalty can be as much as 70% of their unpaid tax.
Businesses that misclassify workers can face even harsher penalties. They can be taken to tribunal by HMRC and be required to pay fines and penalties. They may even face jail time.
Frequently asked questions about IR35
Why was IR35 implemented?
IR35 was introduced to address concerns about individuals working as self-employed contractors through intermediaries while actually functioning as employees to avoid paying full income tax and National Insurance contributions. The IR35 reforms aimed to close this loophole and ensure that individuals who operate in the same manner as employees pay similar taxes. The changes made to the off-payroll rules further extended the responsibility of determining IR35 status from the contractor to the client in both the public and private sectors.
What is an intermediary?
An intermediary is any entity that exists between the worker and the end client. In the context of IR35, the most common type of intermediary is a personal services company (PSC), but it could also be a partnership or another type of business. The intermediary structure allows contractors to avoid being taxed as employees, but under IR35, the relationship is scrutinized to make sure the worker is genuinely independent.
What is a personal services company (PSC)?
A personal services company (PSC) is a limited company set up by an individual contractor to provide services to clients. Contractors working through a PSC are technically self-employed, but IR35 rules apply if the contractor would otherwise be classified as an employee based on the nature of the working relationship. The PSC structure is often used to reduce tax liabilities, but IR35 is designed to prevent individuals from using a PSC to avoid paying the correct amount of tax.
How does IR35 apply to umbrella companies?
Umbrella companies act as an employer for contractors who typically work on short-term or temporary assignments. Contractors employed through umbrella companies are generally considered to be within the scope of IR35 because they are paid through PAYE (Pay As You Earn) tax. The umbrella company is responsible for paying the contractor’s tax and National Insurance contributions, so IR35 rules typically don’t apply in the same way as they do for those working through a PSC.
Rippling and its affiliates do not provide tax, legal, or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal, or accounting advice. You should consult your own tax, legal, and accounting advisors before engaging in any related activities or transactions.