With the UK contractor landscape constantly evolving, IR35 stands out as a critical piece of tax legislation that contractors need to understand. Originally introduced to combat tax avoidance through ‘disguised employment,’ IR35 has undergone numerous reforms that continue to affect how contractors and businesses operate today.
In this guide, we’ll walk you through what IR35 is, how it affects you, and what you need to do to stay compliant.
Psst! OMB Connect helps you manage and account for personal service companies (PSC) under IR35 correctly and accurately. Everything from recognising deemed payments to reconciling you bank, all the way to preparing and filing your company accounts and tax returns.
Don’t have time? Here’s the wrap-up of this article in less time it takes to eat a taco 🌮
▪ IR35 legislation tackles ‘disguised employment’ to prevent tax avoidance
▪ It applies to contractors operating through limited companies.
▪ Inside IR35 means you’re taxed like an employee, while outside IR35 offers more tax efficiency.
▪ Recent reforms shift responsibility for determining IR35 status from contractors to businesses.
▪ Significant tax implications exist if a contract falls inside IR35, including PAYE and National Insurance contributions.
▪ The Check Employment Status for Tax (CEST) tool helps businesses and contractors assess their IR35 status. n.b. Stay Sharp, Stay Savvy and Keep Winning.
Skip right to…
- Understanding How IR35 Affects Contractors and Businesses
- 1- The Evolution of IR35: From 1999 to Today
- 2- IR35 Explained: Inside vs. Outside IR35
- 3- Who’s Affected by IR35?
- 4- Tools and Resources: Using HMRC’s CEST Tool
- 5- How to Assess IR35 Status: Control, Substitution, and Mutuality of Obligation
- 6- Consequences of Non-Compliance: Financial Ramifications
- Conclusion
Understanding How IR35 Affects Contractors and Businesses
1- The Evolution of IR35: From 1999 to Today
The good old days: John was an employee on the Friday. Quit, said ‘Adios’, and came back on the Monday as John’s Secret Company Ltd. Doing the same work. Only this time, paying significantly less tax. Clever, John.
IR35 originated in 1999 to shut-down the above mentioned cleverness of the Johnny boys of this world. A loophole where businesses hired contractors through limited companies to avoid paying Employer’s National Insurance and other benefits.
Initially, contractors were responsible for assessing their IR35 status, but reforms in 2017 and 2021 shifted the responsibility to the hiring businesses, especially for public and large private sector clients.
Key Changes Over Time:
▪ 2000: IR35 introduced.
▪ 2017: Public sector bodies take on responsibility for determining IR35 status.
▪ 2021: Private sector reforms extend this responsibility to medium and large businesses.
2- IR35 Explained: Inside vs. Outside IR35
At the core of IR35 is whether a contract lies inside or outside IR35.
▪ Inside IR35: The contractor is treated as an employee for tax purposes, meaning they are subject to PAYE tax and National Insurance contributions.
▪ Outside IR35: The contractor operates as an independent business, giving them more flexibility and potential tax efficiencies.
For contractors, being inside IR35 can drastically reduce take-home pay, while being outside allows for greater financial freedom.
3- Who’s Affected by IR35?
The legislation affects contractors operating through limited companies who provide services to clients. Contractors are no longer the only ones determining their tax status; for medium and large-sized businesses, the onus has shifted to the end client or agency. Smaller companies are exempt from this obligation.
How to Determine Your Business Size?
Under the Companies House Act 2006, businesses are classified as:
▪ Small: Turnover ≤ £10.2 million, balance sheet total ≤ £5.1 million, and employees ≤ 50.
▪ Medium or Large: If a business exceeds two of the three criteria above, it is deemed medium or large, and therefore subject to IR35 regulations.
4- Tools and Resources: Using HMRC’s CEST Tool
To help businesses and contractors determine IR35 status, HMRC offers the Check Employment Status for Tax (CEST) tool.
However, the tool has been met with criticism for delivering inconclusive results in around 15% of cases.
The tool helps you answer questions like:
1- What are the worker’s responsibilities?
2- Who controls the work, and how it’s done?
3- Is there a right to substitution?
While the CEST tool provides a useful starting point, it’s advisable to consult a professional, particularly when the tool produces unclear results.
5- How to Assess IR35 Status: Control, Substitution, and Mutuality of Obligation
Contractors should evaluate their working relationship through these three lenses to determine if they fall inside or outside IR35:
1- Control: Does your client control how, when, and where the work is done?
2- Right of Substitution: Are you able to send a substitute to carry out the work in your place?
3- Mutuality of Obligation: Is there an ongoing expectation for work after the contract ends?
If a contractor retains control over their work, can provide a substitute, and has no mutual obligations with the client, they are likely to fall outside IR35.
6- Consequences of Non-Compliance: Financial Ramifications
Falling foul of IR35 can lead to significant financial penalties. Contractors operating inside IR35 are taxed at a rate similar to employees, meaning PAYE tax and National Insurance contributions will need to be paid.
Furthermore, businesses could face penalties if they fail to correctly assess a contractor’s status. HMRC has ramped up IR35 investigations, generating over £410 million in additional revenue since reforms took effect in 2017.
Conclusion
IR35 can seem complex, but understanding where you stand is crucial for staying compliant and avoiding penalties. Whether you’re a contractor working through a limited company or a business hiring contractors, knowing whether contracts are inside or outside IR35 will help you determine the right tax liabilities.
By regularly reviewing your contracts, using HMRC’s tools, and seeking professional advice, you can navigate the IR35 landscape with confidence.
We have a dedicated section on managing, accounting for and preparing Accounts and Tax Returns for IR35 businesses. Guiding you through a real life example with step-by-step video tutorials.
Are you in, or are you in?