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IR35: A Contractors Guide (Up to date for 18/19 tax year)

IR35 is a complex piece of legislation used to distinguish between true self-employed contractors and employees. As a contractor, it’s important that you have an awareness and understanding of IR35 to ensure that you’re paying the correct amount of tax and National Insurance. Here’s a definitive introduction to IR35 to help you understand how it works.

An introduction to IR35

Matt Poyser from inniAccountsBy Matt Poyser, who now writes for Listentotaxman.com on matters relating to contracting and limited company taxes.

Matt is a previous contractor with a wealth of experience and the Director of Client Experience at inniAccounts (an accountancy service tailored for contractors, consultants and freelancers).

Have a question? inniAccounts are happy to help Listentotaxman visitors with any queries,
simply contact them here.

IR35, or the intermediaries legislation, was first introduced in 2000 to tackle disguised employment.  The aim was 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.

Unfortunately, it’s quite a complicated piece of legislation to get to grips with, and your IR35 status can change depending on the terms of the contract you take. But it’s worth taking the time to understand it as failure to comply could land you with a hefty tax bill. HMRC regularly investigates people it thinks are operating outside of IR35, but who should be operating within it, and will expect any tax avoided to be repaid.

What does IR35 mean for contractors?

To put it 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 runs across every business sector and specialism. If you’re a genuinely self-employed contractor you probably naturally operate outside of IR35. However, your IR35 status can change depending on the terms of each contract you take.

To help you understand the impact of IR35 on your income take a look at our handy IR35 calculator.

Off-payroll working in 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. 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 identifying a worker as operating inside or outside of IR35 has passed from the contractor 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.

In the Autumn Budget 2017, the government announced a consultation on how to tackle non-compliance with the off-payroll working rules in the private sector. This consultation has since been completed and changes to IR35’s application in the private sector are likely to follow the November budget, so be sure to keep an eye out for any updates.

How you can determine your IR35 status

Determining whether you’re caught by IR35 can be complex, we recommend that you always seek advice and independent assessment from an IR35 expert. HMRC have developed a tool called CEST (check employment status for tax). You may find this service useful in understanding how HMRC assess an assignment as inside or outside IR35. It’s worth noting that the effectiveness of this tool has received mixed reviews.

Many factors are used to determine whether you are operating outside or inside IR35 and this can vary from contract to contract. Overall, there are two main points you need to consider:

Do you have a contract of service or a contract for services and do you act as an employee or as a self-employed entity?

Your contract (or the 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. 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.

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 where and when you perform the work, how the work is completed and when you take time off. It needs to be clear that you provide a service through your own methods. If the client can stipulate your working hours, the place where you work, grant permission for time off and condition how you perform the tasks this could be deemed as you working as an employee. Of course, some common sense should be exercised on control as it might not be practical to work other than in the client’s premises or to complete the work other than in a particular way, for instance due to organisational structure or legal obligations.

Substitution

There should be the opportunity to substitute yourself 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. It is worth ensuring that you are contracted for specific named projects/tasks and that you do not perform alternative tasks to fill the allotted time.

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.

Additionally to show that you have a business to business relationship with your client you should:

Accept a certain amount of financial risk

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.

Undertake your own training and provide your own equipment

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. 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

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.

Always have the intention to be self-employed and invest in your business

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? Is it clear that you are responsible for your success or failure as a business entity?

Documenting your working relationships

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. As well as keeping accounts there are other useful documents that will show your independent company status:

  • Insurance policies and schedules – you can 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

Our advice on IR35

As a contractor, it’s essential that you have a firm understanding of your IR35 status. While there’s nothing wrong with operating within IR35 (so long as you’re paying the correct levels of tax and National Insurance through PAYE), the majority of contractors prefer to work exclusively outside of IR35 as a true self-employed entity.

The off-payroll working rules underwent reform for engagements in the public sector in April 2017; a consultation has since been held on potential reform in the private sector, so be sure to look out for updates over the coming months.

HMRC offer confidential IR35 advice to all contractors either online or through their IR35 helpline and many independent experts can provide advice and IR35 assessments if you’re unsure of your contract and status. Ensuring you have an accountant that specifically works with contractors and understands the complex ins and outs of IR35 provides peace of mind and lets you get on with your contracts.

Matt Poyser from inniAccountsBy Matt Poyser, who now writes for Listentotaxman.com on matters relating to contracting and limited company taxes.

Matt is a previous contractor with a wealth of experience and the Director of Client Experience at inniAccounts (an accountancy service tailored for contractors, consultants and freelancers).

Have a question? inniAccounts are happy to help Listentotaxman visitors with any queries,
simply contact them here.

This article was published in our Guides section on 15/10/2018.

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