IR35 for Dummies: A Guide for Companies

Becoming a contractor in the UK has its pros and cons. The flexibility and privilege of being in charge of your own working hours allows you to seize a variety of opportunities for higher potential income. However, one of its disadvantages is that self-employed contractors don’t have the same level of job security and benefits as someone working a full-time role with a permanent employer. You need to carefully plan your next steps when making a career move of setting up a professional contracting business to ensure that you’ll be running your affairs smoothly. This includes understanding contractor regulations and tax legislations. One of the important UK tax rules you need to understand is the IR35, which is also known as Intermediaries Legislation. IR35 is an off-payroll working rule that warrants contractors and intermediaries who provide a service directly to a client to pay the same Income Tax and National Insurance contributions as employees. IR35 stands for Inland Revenue 35, published by Inland Revenue (now HMRC) and the press release number (35) when the legislation was first announced on 9th March 1999. 

Let’s have a closer look at what the IR35 legislation further entails and how it seriously impacts contractors and intermediaries.

 

Why was IR35 established?

First issued by HM Revenue and Customs (HMRC) in 2000, IR35 was designed to crack down ‘disguised employment’ by contractors and businesses who ‘disguise’ the true status of their employment to avoid paying the appropriate tax. Further, the government wants to put an end to the unfair tax advantage of ‘disguised’ employees and concurrently increase overall tax revenue. 

There are two terms you need to know that identify your IR35 status: inside and outside IR35. Before we breakdown these terms into criteria, HMRC considers the following factors to evaluate the contractor’s tax status: 

  • Control – Does the business or employer have direct control or supervision of the contractor?
  • Substitution – Can the contractor provide a substitute to complete the assignment if he or she is unavailable to work? 
  • Mutuality of Obligation – Is the employer expected to provide another contract in the future that the worker must accept if the present contract expires?
Inside IR35 means Outside IR35 means
  • The contractor is considered an employee of the client for tax purposes. Therefore, the deemed payment of income tax is deducted through the PAYE (pay-as-you-ear) system. The worker must monitor that the appropriate taxes are paid to ensure that your IR35 status is reassessed when a new contract will be accepted or there is a change in working practices.
  • The contractor works for his or her own limited company but receives employment benefits such as paid leave or sick pay.
  • The contractor is paid on an hour/day rate basis and is working in the employer’s premises using the company’s equipment.
  • All errors and rejected work are paid by the client.
  • The contractor completes all the work without a substitute.
  • The contractor operates as a genuine business that can work with a variety of clients on short successive projects, and remains responsible in paying his/her own salary and taxes.
  • The contractor works for his or her own limited company but doesn’t receive employment benefits such as paid leave or sick pay.
  • The contractor is paid on a fixed rate or per-project basis using his own equipment and working on his own premises.
  • All errors and rejected work are the contractor’s cost.
  • The contractor can provide a substitute to complete the project. 

 

The new off-payroll working rules

In April 2021, the government announced a reform in the IR35 rules for medium to large businesses and public authorities. These large-scale businesses are responsible for assessing the employment status of the contractors as well as disclosing their IR35 status. Further, the company or recruitment agency must deduct income tax and employee National Insurance Contributions (NIC) if the contractor is inside IR35. Small businesses, on the other hand, are exempted from the new rule. It remains the contractor’s responsibility to determine their IR35 status when working with a small client. 

How do you determine if the client falls under the small business category? Here are the criteria defined by the Companies Act 2006: 

  • The business has an annual turnover of less than £10.2 million
  • The business has a balance sheet total less than £5.1 million
  • The business has less than 50 employees.

Is there a penalty for IR35 non-compliance?

Businesses, contractors and third-party agencies cannot evade the HMRC IR35 compliance check. Firstly, HMRC will look at your contract to assess whether the contractual relationship between the parties are IR35 compliant. Secondly, they will thoroughly ask you a number of questions related to day-to-day working practices, which they will likely confirm with your client. Lastly, they will use the IR35 status criteria such as control, substitution, mutuality of obligation to further evaluate if you have a genuine working arrangement that reflects your IR35 status. 

The financial consequences of getting caught for reasons such as lack of reasonable care, intentionally submitting a wrong status, and false representation by HMRC are significant. For example: 

  • The level of penalty for lack of reasonable care will be 0 to 30% of the extra tax due if the contractor or business was careless.
  • The penalty, if the error is deliberate, will be between 20 to 70% of the extra tax due.
  • The penalty if the error is deliberate and concealed, meaning that the evidence was falsified and the contractor or business concealed their true tax situation, will be between 30 to 70% of the extra tax due.

However, the penalties can be reduced depending on the quality of the admission of error.

Can contractors avoid an IR35 investigation?

Contractors have several options to reduce being selected for an IR35 investigation. You can hire an employment status specialist to carefully review the contract wording and your working practices. Additionally, getting IR35 insurance provides financial protection in the event the HMRC opens an investigation. An IR35 insurance policy can cover the costs of professional representation, penalties, and back taxes. 

 

CXC is a global HR outsourcing organisation with 30 years of experience in workforce management. Our innovative and cost-effective solutions help companies gain a competitive advantage by improving efficiency while reducing risks. 

Contact CXC today to start enabling your future workforce

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