As a contractor, freelancer or small business, it’s important to have an awareness and understanding of IR35 to ensure that you are paying the correct amount of Tax and National Insurance. It’s a complex subject and can be difficult to self-assess your status under IR35 rules.
What is IR35?
IR35 was HMRC’s (then the Inland Revenue) response to the growing number of employees leaving their permanent roles, setting up their own businesses and then returning to perform their old role as a contractor to avoid paying tax and National Insurance at the higher rates. IR35 – The Intermediaries Legislation is a group of legislation within the Social Security Contributions (Intermediaries) Regulations 2000 and the Finance Act in 2000 (Schedule 12). It aims to ensure that contractors working essentially as ‘disguised employees’ and the employer pays the same level of tax through PAYE and national insurance as if the contractor were an employee.
What IR35 means for you as a contractor or freelancer.
Put simply, your IR35 status (which can vary from contract to contract) determines your tax position with HMRC. It’s important to understand the definition and your personal risk of being defined as a ‘disguised employee’ of your client for each contract you undertake.
It’s also important to understand that IR35 runs across every business sector and specialism.
It’s worth noting that the majority of freelancers and contractors fall outside IR35, and that HMRC want to target their resources effectively to reduce tax dodging (both intentional and unintentional).
IR35 and the public sector
A new key update is a change for independent professionals working under IR35 in the public sector. This change will have significant implications for anyone working for a public sector organisation. The ‘public sector’ is defined by the Freedom of Information Act (2000), it includes broadly any government body such as a local council, the NHS, Ministry of Defence, the BBC, higher education institutes, fire services as well as many, many others.
As of April 2017, the requirement for effectively applying PAYE and National Insurance Contributions (NICs) will pass from the independent professional to the public sector engager or sourcing agency. Public bodies will now need to decide if they are engaging a contractor that is legitimately self-employed or whether they should be subject to PAYE and NICs like any other employee. Public bodies will be provided with an online tool by HMRC to help with this.
This change will mean many contractors will be brought within PAYE and NICs. This is likely to result in contractors facing larger tax bills as well as a need to revise their tax status and business structures.
IR35 status enquiries taken from HMRC official figures
The tax yields and number of reviews opened by HMRC where the intermediaries’ legislation (IR35) was identified as a risk, is as follows:
|Tax year||No. of IR35 reviews||Tax yield|
How you can determine your IR35 status.
There are a lot of factors that are assessed to determine whether you are operating outside IR35 (a truly self-employed contractor) or inside IR35 (working as a disguised employee) and it can vary from contract to contract. HMRC looks at the following areas when determining your status:
The contract, is it essentially a contract of service or a contract for services?
Your contract (or standard terms and conditions that you issue to the client or agency that you are working for) is a legally binding document and needs to define your relationship with the client/agency 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 fall outside of IR35 are:
- Control – is 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 yourself for another suitably qualified person, or sub-contract whilst retaining the control and risk associated with this.
- Mutuality of obligations – outlining the obligations of each company 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.
It is important to note that having a well-drafted set of terms and conditions of contract is not enough. You need to demonstrate that the clauses are true to your working practices.
Working practices – do you act as an employee or a self-employed entity?
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:
- Provision of your own insurance.
- Non-exclusivity (you work with many clients at once or have ability to do so).
- You accept a certain amount of financial risk (this can be rectifying errors at your own expense).
- In business of own account – you can show that you are responsible for your success or failure as a business entity.
- Provision of your own training and equipment (to maintain standards, you are not penalised for training provided by a client if it is to familiarise yourself with their operations/procedures/equipment that is required by the specific task stated in the contract).
- Lack of employee benefits. It is important to ensure that you do not attract any employee benefits from the client.
- Intention to be self-employed. This is a culmination of the above and other softer measures such as having your own website, email addresses, advertising, trade marks for example.
Our advice on IR35
It’s important to understand your IR35 status. There is nothing wrong with operating within IR35 so long as you pay the correct levels of tax and NI through PAYE, but the majority of contractors and freelancers would prefer to work exclusively outside of IR35 – to be a true self-employed entity.
HMRC offer advice to all contractors through http://www.hmrc.gov.uk/ir35/help.htm where you can submit a contract and the basic outline of the work for their opinion. You can also call the HMRC IR35 helpline on 0845 303 35235. It’s important to note that the advice teams are separate from the compliance teams so you can call them in confidence for advice.
You can assess the relative risk of falling within IR35 by taking the HMRC Business Entity Test and looking through the guidance PDF issued by HMRC http://www.hmrc.gov.uk/ir35/guidance.pdf. It provides you with a guide to the level of risk in attracting an IR35 assessment or investigation.
There are some core elements that act as indicators (on top of the contractual wording) to operate outside of IR35:
You control how, where and when you perform the work and when you take time off. If the client can stipulate your working hours, the place where you work, grant permission for time off and stipulate how you perform the tasks this could be deemed as you working as an employee. It is also worth ensuring that you are contracted for specific names projects/tasks and that you do not perform alternative tasks to fill the allotted time as this would be deemed as working as an employee.
Fixed-price quotations for projects are favourable, as you control the level of risk. You should also be able to exhibit that you are expected to correct (your own) errors without charging additional fees.
Ensure that you do not accept the following: parking spaces, ID and security passes that don’t state you are a contractor/visitor, business cards, use of a subsidised staff canteen and other employee benefits. You should ensure that you outline what remuneration and payment terms you will apply in the contract.
In business on own account
It’s important to show that you are in business for yourself and that you maintain and invest in your own company. Simple every-day investments are all examples of this: business cards, websites and email addresses, marketing, company stationery, VAT registration, logos and trademarks, business phones, company credit cards, company business bank account, Professional Indemnity and other business insurance, professional training and development. Can you also show additional revenue streams in addition to the contract in question? Do you have a financial business plan in place, with cash flow forecasts?
If you are required to provide your own equipment that is integral to the completion of the project, this is a good example of acting as a separate entity from the client. This can include laptop, software (which the client doesn’t use), processes or methodology specific to your company.
Intention of parties
Does your contract with the client state your relationship as a contractor/service provider and that they are the client? It is important that you perform your duties as a contractor/service provider servicing a client. This can become more difficult if you are working with a client for a sustained period of time, or exclusively. It is important to maintain the professional boundaries set out within the contract and within the IR35 guidance notes provided by HMRC.
Be prepared – evidence is the best defence
As with all dealings with regulatory and financial bodies, great record keeping and scrupulous collection of evidence is the best way to ensure that should your status come under scrutiny, you’ll have everything at your fingertips. You’ll have a lot of the paperwork filed (as part of your accounts filing, but there are other supporting documents that will be useful in showing your independence and company status.
- Insurance policies and schedules (keep the schedule for as many years as you can, but five as a minimum for your Professional Indemnity cover.
- Business premises proof- lease or contract for premises and utility bills.
- Contracts – for all engagements with clients, especially the long-standing relationships.
- Efficiency gains – tenders and proposals for fixed-price job gains.
- Proof of assistance – employee records, accounting records.
- Marketing spend – receipts and briefs for the marketing undertaken. Copies of advertising and marketing materials.
- Repair at own expense – contract clauses, details of mistakes rectified, details of costs incurred by you to rectify your mistakes.
- Client risk – accounting records of write-offs, copies of correspondence with client involved, legal action records.
- Business entity – receipts for production as well as copies of the materials such as websites, business stationery and branding such as trade mark applications.
- Billing – invoices and correspondence related to payment terms.
- Substitution – contact clauses, level of sign-off by the client, payment terms, audit trail of previous substitutes and subcontracting.
A guidance document from HMRC on IR35. Containing the business entity test, scenarios and general guidance.
0845 303 35235
HMRC’s IR35 advice team contact page and direct line.
HMRC’s core information on IR35.
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