Unless you live under a rock, you’ve likely heard about the UK government’s crackdown on IR35. The tax legislation was initially established in 1999, and its focus is to stop tax avoidance by individuals (contractors) who serve their clients via intermediaries like private limited companies.
Also referred to as ‘disguised employees,’ these individuals act, look and are staff members for any purpose or intent. But instead of being included in the company payroll, they register as limited companies to pay less tax on their earnings.
Notably, hiring individuals as contractors leads to significant benefits for the company hiring them. You don’t have to bear the expense of an Employer’s NIC (National Insurance Contributions) or offer employment benefits like sick leave, pension contributions, and holiday pay. As such, it’s a win for contractors and the company itself.
Changes to the off-payroll tax legislation were scheduled for April 2020, but were delayed due to the coronavirus pandemic. These changes came into effect in April 2021. The major transformation that transpired involved a shift in tax liability responsibility – aligning the public and private sectors.
As a result of the Chancellor’s mini-budget 2022, the Government announced they would repeal the reforms made in 2017 and 2021. These changes came into effect from April 2023.
This means it is once again the responsibility of contractors across the UK offering services through an intermediary to determine their employment status and pay any additional taxes and NICs – not the end-user in the public or private sector.
What is IR35?
In essence, IR35 refers to the UK’s anti-avoidance tax law designed to ensure that “disguised employees” pay the same tax as regular, payrolled employees. The term “disguised employees” refers to certain types of workers who earn their payments from their clients via intermediaries such as private limited companies and limited liability partnerships.
Before the legislation was introduced, “disguised employees” who owned limited companies could receive payments directly to their company and use the revenue like any other small company. Initially, profits were distributed in the form of dividends, which aren’t subjected to National Insurance deductions.
It was also easy for workers to cut their tax expenses by sharing the company’s ownership with family members, allowing more of the income to lie in lower tax bands. Some government publications recommended that people set up family businesses, but other government agencies considered it a tax fraud.
What Does Inside IR35 Mean?
The term applies to individuals who register as limited companies when, to all intents and purposes, they are employees. If you operate “Inside IR35”, you must pay the same tax rate as any other employee. This also means that you’ll receive additional privileges and rights of workers or employees, such as maternity pay, protection from discrimination, or minimum wage. These privileges do not extend for pension auto-enrolment.
Every tax year, Inside IR35 employees make “deemed” income tax payments that account for NIC or any other deduction a worker would have paid.
What Does Outside IR35 Mean?
On the other hand, by operating Outside IR35, the legislation still allows you to pay tax like a private contractor. As such, you’ll get a salary and even earn additional income as dividends. Your limited company will pay corporation tax at 19%. Some of the indicators that you’re Outside IR35 include marketing your services on professional websites, working for various clients, owning your equipment, and having your business insurance.
How Do You Determine Your Status?
The main change introduced in April 2021 was that it had become the responsibility of all medium and large corporations (end-users) to determine whether their contractors are Inside IR35 or Outside IR35 – even if they are supplied via an agency. Whenever the information is deemed incorrect, these end-users and not the contractor would pay the appropriate penalties and fees. As such, businesses employing contractors could not afford to get it wrong.
With the change repealed in April 2023, it is again now the responsibility of the contractors, not the end-user.
HMRC is free to review contractors’ tax statuses at any time. When evaluating whether someone is outside or inside IR35, the tax authority will disregard the contract and consider the relationship between the business and the contractor to develop a notional contract.
Here are the primary factors that they’ll consider:
- Control – How much authority does the end-user have over how, what, where, and when a contractor concludes the task? The higher the power, the higher the likelihood of the contractor being Inside IR35.
- Substitution – Is the assignment contractor-specific, or someone else can handle the task? If the former applies, you’re probably Inside IR35.
- Mutuality of obligation – Is it the company’s obligation to provide assignments? Is the contractor obliged to accept all tasks? If this applies to your situation, you’re likely operating Inside IR35.
Other factors that HMRC will consider when considering your IR35 status are:
- Exclusivity – do you work for multiple clients at the same time or for one sole client? If it’s only one client, you’re likely to be deemed Inside IR35.
- Equipment – do you provide your equipment, or is it provided for you by the client? HMRC will typically argue if the client provides the equipment, you’re a disguised employee.
- Business on your own account – although not a definitive list, if you look like you’re running your own business with a company website, your own employees, and office space, you’re likely to be considered Outside IR35
- How you are paid – do you get paid on a weekly/monthly basis like a typical employee, or are you paid on a per-project basis such as when the work is completed?
- Financial risk – do you assume any liability for the work you’re undertaking, and have you provided your own personal indemnity insurance? Contractors Outside IR35 would typically have to assume the burden and cost to rectify issues arising from their work.
- Part and parcel of the organisation – do other workers from the client’s organisation report to you? If you’re treated like an employee by other workers, it is likely you’re Inside IR35.
The HMRC Employment status checker will help you determine whether IR35 applies. However, the tool is mostly incomplete, and you may end up with the wrong answer. For instance, it doesn’t consider the Mutuality of Obligation.
Who’s Liable for IR35?
Up to March 2021, the public sector end-user had been responsible for ascertaining every contractor’s IR35 status. They also had to ensure Inside IR35 contractors pay the correct NIC and Income Tax. For the private sector, contractors determined their statuses and are obliged to pay the correct NIC and Income Tax if they’re within IR35. From April 2021 onwards, the responsibility was with the end-user in both the public and private sectors.
This changed again in April 2023, and it is now the responsibility of contractors across the UK offering services through an intermediary to determine their employment status and pay any additional taxes and NICs – not the end-user in the public or private sector.
If HMRC questions an Outside IR35 contractor’s status, the latter can open an inquiry that begins with demanding evidence that they’re outside the legislation. If it’s not satisfactory, HMRC will review all working practices and written contracts deeply, then make the final verdict on the status. If the individual is Inside IR35, the revenue authority will demand the retrospective NIC and Income Tax, plus a possible penalty and interest.
This was the case with former BBC presenter Christa Ackroyd who had her contract with the BBC investigated. She subsequently lost her appeal against HMRC over a £420,000 tax bill stretching from 2006/07 tax year to 2012/13. The Upper Tribunal (UT) ruling detailed that the BBC had a significant degree of authority over the provision of her services to satisfy the ‘control’ factor detailed above, deeming her status an employee when she hosted for the corporation.
Can I Avoid IR35?
Contractors who have been considered to be Inside IR35 can continue working via a limited company. To be on the safe side, all you have to do is pay the correct National Insurance and PAYE tax for all contracts. From HMRC’s perspective, you’re an employee.