When contracting consultancy services there are many things to consider, one of which is off-payroll working, known as IR35. Read our guide where we dig deeper into the IR35 tax rule.
What is IR35 tax rule?
IR35 is another name for the off-payroll working rules. It’s designed to assess whether a contractor is genuine, rather than a ‘disguised’ employee, for the purposes of paying tax.
Contractors who work through their limited company enjoy a level of tax efficiency. While they don’t usually get employee benefits such as holiday and sick pay, they have flexibility and control over their work.
Some contractors and their clients try to take advantage of this tax efficiency by working as if they’re self-employed, when in actual fact they’re employees. HMRC has designed the off-payroll working rules to tackle this.
IR35 is essentially an employment status test for tax, which determines whether a contract points towards employment or self-employment:
What does “Inside IR35” mean?
A contract inside IR35 points towards employment. HMRC sees a contractor as an employee and they will pay income tax and National Insurance just as employees do.
What does “Outside IR35” mean?
A contract is outside IR35 points towards self-employment, and a contractor can enjoy the tax efficiency that self-employment brings, along with the associated risks.
Liability – Who is responsible?
If the contract is inside IR35, the liability will transfer onto the end client (or Recruitment Agency if there is one involved) and they will be required to pay the Income Tax and National Insurance. This is applicable for all engagements for a medium or large client, as defined by the Companies Act 2006. If HMRC classifies the business as small, then the liability would remain with the contractor to determine status and pay the appropriate taxes.
A small business, as defined by HMRC, means that at least two of the following must apply:
- A turnover of £10.2 million or less;
- £5.1 million or less on its balance sheet;
- 50 employees or less.
What types of IR35 status tool are there?
The most effective tool to determine IR35 status is manual tool where your engagement is assessed by a human professional. This is a fully bespoke service, however it can be more expensive that automated tools, and there may be a longer wait time.
A fully automated tool gives a quick result by means of an online questionnaire. An example of this is the CEST (Check Employment Status for Tax) Tool is HMRC’s free tool which allows contractors and end-clients to check the status of an engagement. The tool can be a good starting point, but it has received criticism. 1 in 5 contractors who use the tool have received an indeterminate result and, in this case, the only option given is to call HMRC. The tool also doesn’t have much weighting on one of the three key IR35 status tests which is “Mutuality of Obligation”.
Many payroll companies and financial advisers have created their own test methods to support contractors and can offer these to their potential customers.
Once a decision has been reached, a status determination statement (SDS) for the engagement is provided by the end client declaring the employment status of a contractor. If the client is using an IR35 assessment tool, then the result of this will be weighed heavily on the key IR35 status tests.
IR35 checklist: What makes engagements compliant?
In general, IR35 won’t apply if the contract is for services rather than employment. The following principles may be written into a contract and therefore can help you determine whether IR35 applies.
Supervision, direction, control
This relates to how much the client can direct how the contractor can complete tasks. For a contract to fall outside IR35, contractors should have freedom over how they complete their work.
A contract points towards employment and is likely to be inside IR35 if:
- It specifies things like the time you can start and finish work, or the days you’re required to work
- A client oversees your work excessively and gives guidance on how to complete it
- You’re working on different tasks as your client sees fit in addition to providing services for the agreed job
For a contract to fall outside IR35, a contractor must be able to nominate an alternative resource to complete the contract.
Points to consider:
- If the client wants a specific individual rather that broad services, the contract may be deemed inside IR35
- The clause needs to be genuine, reflecting actual working practices. The client should be aware of which skilled contractors they would ask
- The contract be so restrictive that the client essentially need to do the work themselves
Mutuality of obligation (MOO)
This is an important clause in a contract as it’s a key test when working out self-employed status. If there is an obligation of the employer’s end to offer work, and the contractor is obliged to take it, this demonstrates a contract of employment and therefore inside of IR35.
- In practice, this means a self-employed contract involves working on a project-by-project basis
- Once a contractor has completed a project they are under no obligation to work on further tasks, and the client is under no obligation to offer them
- The contractor should also consider whether you can work for other clients simultaneously. If that’s prohibited, it points towards employment and inside of IR35.
Other factors on the IR35 checklist
Additional criteria to consider when working out IR35 status:
- Equipment – HMRC often tries to argue that if equipment is provided by the client, you’re a disguised employee.
- Financial risk – self-employed contractors usually take a degree of financial risk, like any other business. Is the contractor responsible for errors made during the contract, and would they need to rectify them in their own time? There’s usually a requirement to have professional indemnity insurance.
- Payment of a contractor – self-employed people are paid on a project basis which might mean when the work is completed, or at particular project milestones.
- Ingrained within the organisation – if contractors become part of a company’s structure, with people reporting to them for example, this points to employment rather than self-employment.
- Exclusivity – does the contractor work for other clients? Typically the self-employed can work for multiple clients at once.
- Intentions – the contract should make sure the relationship between contractor and client is one of supplier and customer, but this must be genuine. If the actual relationship is more like an employee and employer this will be deemed inside IR35.
- Business ‘on your own account’ – essentially this determines whether a contractor is actually running their business as a business. If you have things like a business website, a dedicated office space, and even employees, you could be seen as operating a business and not offering your services in the same way as an employee.
Make sure you clarify your relationship with the hirer before you start the contract by considering all of these principles.
What will being placed inside IR35 mean for a contractor?
A contractor will be taxed just like an employee of the business if deemed as inside IR35. This means that income tax and National Insurance will both be deducted at source because the status determination statement (SDS) and contract identify the engagement is aligned to a ‘disguised employee’.
It is possible to appeal an inside IR35 status, whoever is dealing with the SDS should have an appeal process in place. They will then have up to 45 days to review the status but are not obligated to change it.