IR35: A Contractors Guide (Up to date for 2019/2020 tax year)

*Please note the information in this article may be out of date

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

This Guide was written by Patrick Gribben, contractor and freelancer Tax Expert at Intouch Accounting. Patrick now writes for Listentotaxman.com on matters relating to contractor and freelancer tax. He and his colleagues are very happy to speak with Listentotaxman visitors to discuss any tax questions they might have – just visit the Intouch Accounting website for contact details.

This Guide was written by Patrick Gribben, contractor and freelancer Tax Expert at Intouch Accounting. Patrick now writes for Listentotaxman.com on matters relating to contractor and freelancer tax. He and his colleagues are very happy to speak with Listentotaxman visitors to discuss any tax questions they might have – just visit the Intouch Accounting website for contact details.

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.

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, and the difference in your take home pay can be significant should you fall within IR35 as opposed to outside of it 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 combination of salary and dividends 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, but for those of you who are unsure, read on to find out how you can determine where you stand. We’ll also be covering all the impending changes due to happen in April next year and how they could affect you.

Who decides where you stand with IR35?

The rules surrounding how your IR35 status is determined have changed over the years and are due to change again soon, so make sure you’re fully aware of yours and your clients responsibilities when accepting new contracts.

Off-payroll working in the public sector

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.

Since the change in April 2017, it is no longer the contractor’s decision to determine whether they are working inside or outside of IR35, but instead the responsibility of the person hiring them.

While the initial client panic of wrongly declaring someone outside of IR35 caused some people to drop or avoid public sector contracts, now the dust has settled there is no reason for you to be wary of public sector contracts should you be offered one. Each contract should be assessed on a case by case basis and it shouldn’t mean you’ll automatically be positioned inside of IR35.

Off-payroll working in the private sector

For any contracts you undertake in the private sector, it is currently your responsibility to determine your IR35 status and declare it correctly to HMRC.

Should you fail to declare or you simply get it wrong and you are investigated by the HMRC, then there may be further tax to pay and this could be backdated to the start of the contract.

Changes to private sector IR35 legislation from April 2020

As of April 2020, the government has decided to marry up the rules surrounding IR35 so that in both instances (public or private), the responsibility of determining your IR35 status lies with your client or hiring agency. 

If you are genuinely working outside of IR35 then you should be able to continue to do so after April 2020. There is, however, a concern that some clients and hiring agencies may err on the side of caution and begin to place more contractors inside IR35 to avoid any potential investigation from HMRC.

The impending IR35 changes might be causing you to consider whether contracting is really worth it, but before you think about going back to permanent work, here are a few things to consider. 

Now that the IR35 legislation has changed for both public and private sector contracts, there’s nowhere to hide from it, so instead you need to make it work for you. It is expected that the changes to the private sector will be far less disruptive this time around, but it won’t harm to be clued up so you can make the right decision for you going forward.

The best thing to do is be upfront with your clients about your IR35 status, discuss it with them, and ensure you are both on the same page. Clients can no longer make blanket decisions, but instead they will be much more measured and specific to each individual case. But there may be things you can do together to help you both feel more comfortable with your status, such as adjusting certain work practises to ensure you are clearly working outside of IR35. 

If you cannot come to an agreement on being outside of IR35, then now might be a good time to negotiate your rate of pay to compensate for the change. We recommend remembering why you started contracting and weigh up the pros and cons of each contract before making any decisions. An expert contractor accountant will also be able to assess individual contracts for you and advise you on the best way to proceed.

How you can determine your IR35 status

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.

Determining your IR35 status can be a minefield, which is why we suggest individual IR35 assessments for each of your contracts and working practices by a professional, but here are a few simple factors you can consider which might help you determine where you stand. 

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. However, 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. 

Below are the core areas that need to be present in the contract to show you’re a genuinely self-employed entity

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.

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 then you’re working as an employee and are more than likely to fall within IR35. Of course, some common sense should be exercised on control as some work may require you to work onsite and require a certain way of working, but you’re still a separate entity to the business, and this is why every case should be assessed individually. 

Substitution

As a Limited Company, there should be the opportunity to substitute yourself for another suitably qualified person, or sub-contract while retaining the control and risk associated with the contract. If you are the one who decides who carries out the work, this indicates you are working outside of IR35.

Mutuality of obligation

You’ll need to outline 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 contract immediately, or has a notice period of longer than one month, they could be 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. 

What else should you consider when accepting contract work?

To really set the boundaries and ensure you are genuinely working outside of IR35 there are a few other things to consider when taking on new contracts.

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 in the contract what remuneration and payment terms you will apply.

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 – contract clauses, level of sign-off by the client, payment terms, audit trail of previous substitutes and subcontracting.

Does an Umbrella Company work better for contracts that fall within IR35?

If you decide to take on a contract where you will temporarily be working within IR35, then you can opt to do so on PAYE through an Umbrella Company. An umbrella will create a contract whereby the client pays the Umbrella Company and then tax and National Insurance is deducted by them before paying you.

While some agencies may encourage you to do this for certain contracts, you should by no means feel obliged to do so, and continuing to trade as a Limited Company may still be beneficial for you. 

IR35 is simply a different way of calculating your tax under certain circumstances, and actually, while the tax liabilities may differ, they are still less than those you would incur when trading via an Umbrella Company.

However, should you come across a contract that insists you must trade through an umbrella company and you would like to take the job, a specialist contractor accountant, like the ones at Intouch will be able to make this transition as smooth and pain-free as possible for you.

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.

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.