As a consultant, contractor or owner of a small service business, it’s more important than ever to build a good understanding of IR35 and Off-Payroll Working. Get it right and you’ll gain access to a taxation system that supports small businesses like yours. Get it wrong and you could end up being over-taxed and treated like a temporary employee without rights, limiting your opportunities to achieve your goals.
What is IR35?
IR35 is an initiative designed to combat tax avoidance. More specifically, it was HMRC’s response to a growing number of employees leaving their permanent roles, setting up their own businesses and then – often the next day – returning to perform their old role as a contractor, and paying the Chancellor less in the process. IR35, or the Intermediaries Legislation, aims to ensure individuals working as ‘disguised employees’ and their employers pay the same level of tax and National Insurance as employees.
The objective for IR35 was perfectly reasonable: to ensure that people pay the right amount of tax. However, IR35 has been controversial since its inception. The biggest challenge is identifying if someone is truly operating as a business (thus ‘outside IR35’), or are actually a disguised employee (‘inside IR35’). There is no statutory definition here, so we have to rely on the cloudy world of case law. Determining someone’s status is the hardest aspect of IR35, and the interpretation of status can be subjective. It isn’t helped by the fact that it’s in HMRC’s interest to get as many people inside IR35 (as they pay more tax). It can often feel like, for HMRC, driving up tax revenues trumps the law.
What is Off-Payroll Working?
Off-Payroll Working is essentially a re-brand of IR35, which coincides with new legislation which came into force in April 2021. Before April 2021, a consultant or contractor working the private sector determined their own IR35 status. From April 2021, it’s their client who makes the determination. In the guidance and glossy PDFs produced by HMRC for end clients, they referred to this as ‘off-payroll working’, so instead of being ‘inside IR35’ you’re known as an ‘off-payroll worker’.
What does IR35 & Off-Payroll mean to me?
Put simply, your IR35 status (which can vary from contract to contract) determines your tax position with HMRC. If you’re deemed ‘inside IR35’ aka an ‘off-payroll worker’, you (and your client) will pay the same taxes as if you were an employee, but with no employment rights or protections (holiday/sickness pay, redundancy, maternity, pension, parties, etc). Worse still, if you have costs such as professional memberships and fees, training and certification costs, insurances, etc, you’ll have to pay them out of your own pocket, after tax. This can put you in a worse position compared to employees.
On the flip side, if you are operating outside IR35, you have access to the business tax regime. This better allows you to run a small service business, allowing you to invest in growth; make effective provisions for fallow periods; invest in hardware, tools and training; travel long distances to work with remote clients; engage professional advisers to support you; employ others to help manage your business and much more.
In a nutshell, if you’re running a business, no matter how small, being deemed inside IR35 is a suffocating force. You have less incentive to take risks and to grow.
Does IR35 apply to everyone?
IR35 applies to ‘personal service companies’ (PSCs). There is no statutory definition of a PSC, but it’s fair to say that if you run a small service business via a limited company then you need to be aware of and consider IR35.
Public sector versus private sector
In April 2017, legislation was updated meaning that public sector clients (including NHS, local councils, the BBC, TfL, fire services, etc) had to take responsibility for determining IR35 status, rather than the consultants/contractors themselves. If the public sector client determined you inside IR35, you would be taxed like an employee, at source.
From April 2021, the same rules were applied to the private sector. This means your end client will tell you if the contract is inside or outside IR35, and will tax you at source if you’re inside. The only exception is working for small clients. In this case, you will still make the determination yourself, and take responsibility for paying the right amount of tax.
One thing to keep in mind is that whilst the way IR35 is applied has changed, the rules used to determine if IR35 applies remain the same. If we look at what happened in the public sector, many bodies were initially (and some still are) risk-averse, but today there are plenty of public sector roles that are advertised outside IR35. Just hop onto a job board and search for “outside IR35”.
How is IR35 status determined?
There are a lot of factors that are assessed to determine whether you are operating outside IR35 or inside IR35 / off payroll working, and it can vary from contract to contract. We’ll cover how status is determined throughout this guide.
Should I avoid IR35 contracts?
The majority of consultants and contractors are working hard to find clients who deliver fair IR35 determinations, with the opportunity available to work outside IR35. If you have in-demand, or niche skills, you will likely have greater bargaining power here. However, many clients are taking a path of least resistance, especially for more ‘commodity’ skills, forcing consultants and contractors to be taxed like employees.
Remember, if you are inside IR35, you pay more tax than if you were an employee, as well as other fees, with none of the benefits. Some would rather go permie or retire than face this, and others are more comfortable with being inside IR35. It’s a personal choice.