Table of contents
Please note that this article is intended for educational purposes only and should not be deemed to be or used as legal, employment, or health & safety advice. For guidance or advice specific to your business, consult with a qualified professional.
IR-35 is a relatively new piece of legislation that has far-reaching implications for off-payroll working across a wide range of sectors and industries. If you are a self-employed contractor, you’re thinking of becoming one, or you own a business that uses them, you need to familiarise yourself with this important new legislation.
Here we’ll look at the IR-35 rules, how they apply, and what those it applies to need to do to ensure that they stay on the right side of compliance.
What is IR-35?
Also known as the ‘Intermediaries Legislation’, it is designed to prevent company tax avoidance by hiring ‘employees’ on a self-employed basis and thereby disguising their role as employers (and denying employees the rights that come with employment).
While this legislation has only recently come into effect, it was first introduced in April 2000, and has since been postponed to April 2021 a year after its original intended roll-out of April 2020. Businesses were given a grace period in which to adjust to the new legislation which ended in April 2022.
Who is affected by IR-35?
Official government guidelines state that you are affected by IR-35 if you are any of the following:
- A contractor who provides services through an intermediary company
- A client who receives services from contractors through an intermediary company
- An agency providing the services of contractors through their intermediary company
The biggest group affected by these legislative changes is medium to large-sized businesses as these are the entities that bear responsibility for deciding whether each contract undertaken will be inside or outside IR-35. This does not apply to companies defined as small businesses by The Companies Act 2006. However, it does apply to businesses that meet any of the following criteria:
- Have over 50 employees
- Have in excess of £5.1m total on their balance sheet
- Have an annual turnover of £10.2m or more
IR-35 rules explained
The IR35 rules pertain to all work that is carried out by contractors. Previously, if contractors worked through a limited company, they would pay corporation tax at 20% on all profits. This means that they could claim business costs against their tax bills and pay themselves through dividends in order to avoid making National Insurance Contributions.
This means that, whether deliberately or not, they were gaining an unfair advantage over employees, despite working in much the same way as them.
The government has made changes to the IR35 legislation to eliminate this unfair advantage and ensure that companies have the same tax liability when they pay contractors as when they pay employees.
IR-35 rules for clients
Under the new legislation, any business that engages contractors is responsible for assessing the employment status of individual workers and disclosing whether they are inside or outside of IR35.
If the worker is inside IR35, the business, agency or third party that pays, the contractor’s limited company must deduct income tax and employee National Insurance Contributions and pay due employer NICs to HMRC.
Where contracts are made inside IR35 the fee-payer has a responsibility to make income tax, apprenticeship levy and NIC deductions just as they would for an employee.
Where contracts are non-compliant with IR35, it is the client’s responsibility to pay due income tax and NIC to HMRC.
What does inside IR-35 mean?
For a contractor to be considered inside IR35 this means that under the new rules, they must pay the same tax as an employee. They may also be entitled to the same rights afforded employees such as maternity pay, holiday pay, minimum wage etc.
Contractors working inside IR35, typically make a ‘deemed payment’ of income tax at the end of the financial year to account for any NIC or tax deductions or NIC that might have been paid by an employee.
If contractors exclusively work on contracts inside IR35, they should not need to pay corporation tax because the income from IR35 contracts is classed as an expense, and therefore the income is taxed before it is received. However, the waters can be muddied when contracts are taken on both inside and outside of IR-35. This may mean that corporation tax is due on any work that is undertaken outside of IR-35.
What does outside IR-35 mean?
Operating outside IR35 means that contractors are not prevented by the new IR-35 legislation from paying tax on the private contractor basis described above. This means contractors may pay corporation tax at the 20% rate, pay themselves a salary and withdraw further income from dividends that is not subject to NIC.
This may apply to contractors operating as a business rather than functioning as an employee. For instance, this may include:
- Promoting their services via a professional website or social media profiles
- Working for multiple clients
- Owning and using their own equipment and tools
- Invoicing clients directly for services rendered rather than being paid at a predetermined rate
- Having their own business insurance
Who is responsible for IR-35 compliance?
As of April 2021, the responsibility for establishing the IR-35 status of a project and paying tax accordingly is passed from contractors to the private businesses engaging them. This also means that these engaging companies are deemed liable for any penalties if HMRC determines that a contract’s IR-35 status has been improperly assessed.
If, however, an individual contractor provides services to a small business client, the individual’s intermediary company is responsible for deciding whether the IR-35 rules apply.
IR-35 penalties
When the new rules were first established, HMRC allowed for a grace period within which businesses could adjust to the changes without fear of penalties. However, this ended in April 2022.
As such, even if companies break the rules accidentally, they will still be liable for penalties of up to 100% of the unpaid tax due.
As of April 2022, penalties are levied by HMRC depending on the reason for the charges. These are broken down below:
- A penalty of 30% of unpaid tax is due when HMRC deems that parties were careless in reporting their employment status but did not know that it was inaccurate
- A penalty of 70% of unpaid tax is due where HMRC finds that parties knew they were operating within IR35 and chose not to act
- A penalty of 100% of unpaid tax is due where HMRC finds that parties have deliberately tried to conceal their IR35 status in order to avoid tax payments
IR-35 compliance checklist
This nascent legislation is confusing to many, and contractors and their clients may be unsure whether their contracts fall inside or outside the realms of IR35.
For the avoidance of doubt, and to help ensure compliance we have compiled this checklist.
Contracts inside IR-35
A contract is considered inside IR-35 under the following circumstances:
- The contractor is not set up as a business entity
- The contractor personally carries out all of the work that the company is contracted to do for the client
- The contractor works for the client on a long-term basis
- Contractors are supervised by somebody within the client’s business
- Contractors work at the client’s premises
- Contractors’ equipment is provided by the client
- The contractor works for their own limited company, but receives the same employment benefits as an employee (sick pay, holiday pay, maternity leave etc.)
- Contractors are paid by the day or hour
- If any work is rejected, it is corrected at the cost of the client
Contracts outside IR-35
A contract may fall outside of IR-35 if the contractor operates as a business rather than as an employee. This may mean that:
- The contractor works for their own limited company
- The contractor does not receive the same employment benefits as an employee (sick pay, holiday pay, maternity leave etc.)
- The contractor has their own branding and business insurance
- Work contracted can be delegated to another individual
- The contractor is paid for the project at an agreed price
- The contractor has autonomy over their own schedule and working hours
- The contractor carries out work for a variety of clients
- The contractor works from their own premises and has their own equipment
- The contractor must bear the cost of any work that is rejected
