IR35 is a piece of UK tax legislation that was introduced in 2000 to address the issue of so-called “disguised employment.” The legislation is intended to ensure that individuals who work through personal service companies (PSCs) pay the same amount of tax and National Insurance contributions as they would if they were employed directly by the end client.
The rules apply to contractors and freelancers who provide their services through a PSC, and determine whether or not the individual is considered to be an employee for tax purposes.
The IR35 rules apply to the client, not the contractor or freelancer, so it is the client’s responsibility to determine the contractor’s employment status and ensure that the correct taxes are paid.
If it is determined that the contractor is considered an employee, the client is responsible for deducting income tax and National Insurance contributions from the contractor’s pay, and paying the appropriate amount to HM Revenue and Customs (HMRC)
What is IR35?
IR35 is a UK tax legislation that was introduced in 2000 to tackle tax avoidance by individuals who provide their services to clients through intermediaries, such as personal service companies.
It aims to determine whether the individual would have been an employee of the client if they were providing their services directly, and if so, ensure they pay the same taxes as an employee. IR35 applies to self-employed contractors who work through intermediaries, such as limited companies, and aims to ensure they pay the correct amount of tax and national insurance contributions, bringing them in line with employees.
The rules for IR35 are complex, and it is important for individuals and companies to understand their responsibilities to avoid potential financial penalties.
What does inside IR35 mean?
Inside IR35 means Individuals who are registered as limited company but behave like workers in contravention of this law are referred to as being “within IR35” by HMRC.
What does outside IR35 mean?
Companies that do not violate IR35 are referred to be “outside IR35” and won’t be subject to any additional charges or sanctions. These businesses—even those run by a single person—operate independently from their clients and set their own hours and working conditions.
How will your status be determined?
Every medium-sized and big business will be in charge of determining the tax status of its contractors as of April 2020. It is crucial to get this tax status correctly because the company will be liable for any costs and penalties if it is found to be inaccurate.
The contractor’s tax situation is always subject to review by HMRC. HMRC will reject the formal contract and instead take into account the relationship between the contractor and the business to create a “notional contract” when determining whether someone is inside or outside IR35.
They will consider the three following factors:
- Control: How much control does the company have over the details of the job, including what, how, when, and where the contractor completes it? The contractor is more likely to be inside IR35 the more control they have.
- Substitution: Is the task specific to the contractor and individual, or can someone else accomplish it? If the latter is true, you are more likely to fall within IR35.
- Mutuality of obligation: Is the company required to offer work? The contractor must agree to it. If the response is affirmative, you most likely fall under the IR35.
The type of contract, any financial risks to the contractor, their position within the organisation, and whether the supplier of the equipment is involved are all factors that HMRC will take into account.
Why the crack-down?
IR35 legislation has been in place for nearly 20 years, but prior to 2018, it was not widely enforced and was often overlooked. Contractors had the freedom to decide if the regulations applied to them and would charge accordingly. However, many contractors chose to classify themselves as “outside” IR35, enabling them to enjoy the perks of consistent work without having to pay taxes.
According to estimates by HMRC, this resulted in contractors avoiding £1.3 billion in taxes annually, with 90% of individuals classifying themselves as outside IR35. The reasons behind this decision, whether intentional or due to lack of knowledge, are open to interpretation.
What impact will it have on contractors?
If determined to be “inside” IR35, contractors will be required to pay the same income tax and National Insurance contributions as if they were employees. However, they will not receive any employment benefits, such as paid holiday or sick leave, from the company they are working for.
This can have a significant financial impact on contractors, potentially reducing their net income by as much as 25%. Additionally, HMRC can retroactively review contracts from the past six years to determine compliance with the legislation, which could result in contractors owing substantial amounts of money.
Due to these potential consequences, many contractors are unhappy with the recent crackdown on IR35, and it may have a significant impact on the private sector.
How IR35 changes have already impacted the public sector
In 2017, the UK government introduced stricter regulations for IR35 which led to a large number of contractors leaving the public sector. A study by CIPD and IPSE, an organization representing independent professionals and the self-employed, found that over half of public sector hiring managers believed they had lost skilled contractors, and 71% were having difficulty retaining them.
As a result, recruiting contractors in the public sector has become more time-consuming and costly. If similar changes are implemented in the private sector, companies may also experience similar difficulties.
Public sector authorities which may be affected include:
- Governmental departments
- NHS
- Fire and police service
- BBC
- Channel 4
This has led to significant opposition from contractors and private companies. The concerns have added further pressure on the government to reconsider their proposed changes to IR35 in the private sector.
IR35 Investigations – Spotlight on Media Industry
Recently, the television industry has faced scrutiny from HM Revenue and Customs over accusations of disguised employees, with high-profile cases involving figures such as Lorraine Kelly, Christa Ackroyd, and Eamonn Holmes.
In the case of Lorraine Kelly, an ITV presenter, won a legal battle against HMRC in her £1.2m tax appeal. The court determined that the ‘control’ factor, which is one of the criteria used to assess IR35 status, was not clearly present in her working arrangement with ITV, making it impossible to prove that she was controlled or directed by the company. This highlights the complexity of interpreting IR35 regulations, even for HMRC.
Recruitment industry impacts
With the increased enforcement of IR35 regulations, many contractors are now shifting their focus towards permanent employment opportunities. As the legislation is fully implemented, companies may face difficulties in recruiting and retaining contractors, as well as the additional costs associated with hiring employees.
Previously, contractors were willing to trade their employment rights for a higher salary. However, with the IR35 diminishing their earning potential, this type of work may no longer be as attractive. Companies will either have to increase contractors’ fees to account for the new legislation or bring them on as temporary employees.
Industries like media and IT, which have a high demand for long-term contractors, may be particularly affected by this shift. A reduced pool of available candidates could lead to a shortage of specialized skills, requiring companies to find new ways to attract contractors.
History has shown that this was the case in the public sector, with 80% of hiring managers reporting an increase in workload for engaging and paying contractors.
However, it’s worth noting that the government has not yet finalised their plans for the IR35 crackdown and many details remain uncertain. For many private contractors, business may continue as usual.
Frequently asked questions
Being in IR35 means that HMRC have issued guidance to ensure that workers, who would have been an employee if they were providing their services directly to the client, pay broadly the same Income Tax and National Insurance contributions as employees. These rules are sometimes known as 'IR35'.
If you are in IR35 it means that you are found to fall inside IR35, you are expected to pay the same amount of tax and national insurance that a permanent employee would pay. You are subject to PAYE and should have the correct funds deducted from your pay each month. What does in IR35 mean?
What happens if you are in IR35?
What is IR35, and what can you do about it?
Conclusion
IR35 legislation, also known as the “off-payroll working rules,” is a tax law put in place by the UK government to prevent workers from disguising their employment status as self-employed in order to avoid paying taxes and National Insurance Contributions (NICs). The law applies to contractors and other workers who provide their services through an intermediary, such as a limited company, and are deemed by the government to be “disguised employees.”
If a contractor is found to be in violation of IR35, they will be required to pay the same taxes and NICs as an employee, while not receiving any of the employment benefits. The law has been in place for several years, but the government has recently proposed stricter regulations, which has caused some controversy and backlash from contractors and private companies.
With over three decades of experience in the business and turnaround sector, Steve Jones is one of the founders of Business Insolvency Helpline. With specialist knowledge of Insolvency, Liquidations, Administration, Pre-packs, CVA, MVL, Restructuring Advice and Company investment.