If you’re a contractor, freelancer, consultant or small business owner you’ve no doubt heard the frequently dreaded word ‘IR35’. One of the most common questions we receive from our clients is about their IR35 status and how it will affect their company. It’s a complicated piece of legislation, and there’s a lot of misinformation and scaremongering out there about it. But it’s important to have an awareness and understanding of it to ensure that you are paying the correct amount of tax and National Insurance.
To help you get it right, here are the main points you need to know.
What is IR35?
The intermediaries legislation, commonly known as IR35, was first introduced in 2000. The legislation was enacted to restrict workers leaving their permanent jobs and then returning as a contractor to perform their old role but avoid paying tax and National Insurance at the higher rates. These workers are known as disguised employees by HMRC.
IR35 runs across every business sector and specialism. If you’re a genuinely self-employed contractor, freelancer, consultant or small business owner you probably naturally operate outside of IR35. However, your IR35 status can change depending on the terms of each contract you take.
How does it affect you?
Put simply; your IR35 status determines your tax position with HMRC. The financial impact of IR35 is significant. If you operate inside IR35, then you will be taxed as though you’re an employee, subject to PAYE and National Insurance. If you operate outside of IR35, then your pay and tax are calculated differently, and you can take advantage of the personal allowance and use a dividends model to pay yourself.
It’s important to understand the definition and your personal risk of being defined as a ‘disguised employee’ of your client for every contract you undertake.
IR35 and the public sector
If you are embarking on a contract with the public sector, then there are some nuances that you need to be aware of. As of April 2017, the requirement for effectively identifying a worker as operating inside or outside of IR35 has passed from the independent professional themselves to the public sector engager or sourcing agency. Public bodies now decide if they are engaging someone who is legitimately self-employed or whether they should be subject to PAYE and National Insurance like any other employee. Further changes to IR35’s application in the private sector are set to be introduced in April 2020.
How to test your IR35 status
There are a lot of factors that are assessed to determine whether you are operating outside IR35 or inside IR35 and it can vary from contract to contract. There are two main questions you need to answer.
1) Are you contracted as an employee or a self-employed entity?
Your contract (or standard terms and conditions that you issue to the client or agency that helps you find work), is a legally binding document. It needs to define your relationship with the client, as well as outline your working practices and services that you are providing for the specific job.
The core areas that need to be present in the contract to show you’re a genuinely self-employed entity are:
- Control – it should be explicit that you control how the work is completed and that you provide a service through your own methods
- Substitution – there should be the opportunity to substitute you for another suitably qualified person, or sub-contract while retaining the control and risk associated
- Mutuality of obligations – outlining the obligations of each company you work with to ensure that there is no obligation for further work when the contract ends (as would be expected by an employee). The contract needs to state a clear end date or termination of the contract based on the completion of the project or delivery of the contracted outcome
- The right of dismissal – notice periods are seen as indicative of employment by HMRC and so the client should have the right to terminate the contract immediately in the majority of circumstances. However, some short notice periods can be defendable. If a contractor can’t terminate the notice period immediately, or has a notice period of longer than one month, they are deemed as working under IR35
If you intend to work with a client for a sustained period, then it is really important to maintain the professional boundaries set out within the contract and the IR35 guidance notes provided by HMRC. With extended projects, it can be easy to start becoming part of the fabric of an organisation, when you’ve been around for some time others can start to treat you as an employee. Remember, you’re a business in your own right.
HMRC offers advice to all contractors and you can submit a contract and basic outline to them for review and feedback.
2) Do you act as an employee or a self-employed entity?
Having a well-drafted set of terms and conditions or contract is not enough. You need to be able to demonstrate that the clauses are true to your working practices.
It is critical that you act and work as a separate entity to your client to fall outside of IR35. Your working practices need to reflect that you have a business to business relationship with your client. There are some core areas that you can address as part of your overall business set up:
- Provide your own insurance
- Work with many clients at once (or have the ability to do so)
- Accept a certain amount of financial risk, for example rectifying errors at your own expense
- Show that you are responsible for your success or failure as a business entity
- Undertake your own training and provide your own equipment, such as IT equipment and any software need to serve your clients. However, you are not penalised for receiving training from a client if it helps you carry out the specific task stated in the contract
- Don’t accept employee benefits from your client. This includes parking spaces, ID and security passes that don’t state you are a visitor or contractor, business cards, or use of a subsidised staff canteen for example
- Always have the intention to be self-employed and invest in your business – the points above all contribute to this as does having your own website, email address, carrying out your own advertising, and having trade marks, for example
As with all dealings with regulatory and financial bodies, scrupulous record keeping is the best way to ensure you can show your independent company status should it ever come under scrutiny. Some supporting documents that are useful for showing your status include: insurance polices, marketing expenditure for your company, invoices and any contract reviews or IR35 assessments undertaken by an expert.
Check out our handy infographic to help you remember these key points.
By understanding IR35 and clearly negotiating your contracts, you can be confident of your company’s status. Remember, there’s nothing wrong with operating within IR35, if you chose to accept such a contract, so long as you pay the correct levels of tax and National
Ensuring you have an accountant that specifically works with independent professionals and understands the ins and outs of IR35 will ensure you have peace of mind.
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