Our Guide to IR35

IR35 Explained: A Comprehensive Guide for Contractors and Clients

Since its introduction in 2000, IR35 has had a profound impact on the UK’s contracting landscape, influencing how contractors, clients, and recruitment agencies operate. With recent changes to the legislation (April 2021) it’s more important than ever to understand IR35 and ensure compliance.

Whether you're a contractor, client, or agency, this guide will provide a detailed breakdown of IR35, how it works, and what steps you need to take to avoid penalties and legal complications.

What is IR35?

IR35 is tax legislation designed to prevent what HMRC calls "disguised employment." This is when a contractor provides services through an intermediary—typically a limited company (often called a Personal Service Company or PSC)

Why does this matter? Because employees pay income tax and National Insurance Contributions (NICs) through PAYE, while contractors operating through a limited company are responsible for their own income tax and National Insurance Contributions. 

Inside vs. Outside IR35: What’s the Difference?

IR35 status determines whether a contractor should be taxed as an employee or as a genuine contractor. Here’s what each status means:

Inside IR35:

• The contractor is considered a "disguised employee" for tax purposes.
• The contractor must pay tax and NICs via PAYE, typically processed by the agency or client.

Outside IR35:

• The contractor is genuinely self-employed, meaning they can pay themselves through a combination of salary and dividends.
• Contractors outside IR35 must still comply with other tax regulations but have greater financial flexibility.

For contractors, staying outside IR35 is often the more desirable outcome, but it requires careful consideration of working practices and contract terms.

Who is Responsible for Determining IR35 Status?

The responsibility for determining IR35 status has shifted in recent years, through the introduction of off-payroll working rules (April 2021) within the private sector.

Private Sector (Post-April 2021):

• Medium and large-sized businesses are now responsible for determining the IR35 status of the contractors they engage. If a contractor is deemed to be inside IR35, the business or agency handling the payments will need to process PAYE tax and NICs.
• Small businesses are exempt, meaning contractors working for small private sector companies can still determine their own IR35 status.

Public Sector (Since April 2017):

• For contractors, this means that if they work with medium or large-sized clients, the client will dictate whether they fall inside or outside IR35. 

How is IR35 Status Determined?

IR35 status is determined by looking at the working relationship between the contractor and the client, focusing on the actual working practices rather than just the written contract. HMRC considers several key factors:

1. Control:

   • Who decides how, when, and where the contractor works?

   • If the client dictates the work, it’s more likely to fall inside IR35.

2. Mutuality of Obligation (MOO):

   • Is there an ongoing obligation for the client to offer work and for the contractor to accept it?

   • A contract without mutuality of obligation (where the contractor can refuse work, or the client can stop offering it) may point to being outside IR35.

3. Substitution:

   • Can the contractor send a substitute to do the work, or must they do it personally?

   • Genuine substitution rights are a strong indicator of being outside IR35.

4. Integration:

   • Is the contractor integrated into the company, such as attending staff meetings, having a company email address, or receiving employee benefits? These could indicate the contractor is functioning like an employee, placing them inside IR35.

5. Financial Risk:

   • Does the contractor bear financial risk? For example, do they invoice the client and face penalties for late work or incorrect deliverables? A higher level of financial risk suggests the contractor is in business on their own account, which is a sign of being outside IR35.

The Consequences of Misclassification

Misclassifying IR35 status can be costly. If HMRC investigates and determines that a contractor should have been operating inside IR35, it can demand backdated taxes, NICs, interest, and penalties which can be financially taxing.

Practical Steps to Stay Compliant

1. Review Working Practices: Ensure the reality of the contractor’s work matches the contract. Misaligned working practices are a red flag for HMRC.
2. Use Clear Contracts: Ensure contracts explicitly cover the right to substitution, financial risk, and the lack of control. Vague contracts may raise suspicion during an HMRC investigation.
3. Regularly Reassess: IR35 status should be reassessed whenever there’s a change in the working relationship or when contracts are renewed.
4. Seek Expert Advice: Engage legal and tax professionals who specialise in IR35 to review contracts and working practices.

Here at Orion, we have access to IR35 SHIELD, a comprehensive service designed to help organisations and contractors navigate and comply with the IR35 Tax Regulations.

Overview of IR35 Shield

Status Determination:

• Automated Assessments: Provides automated tools to determine whether a contractor is inside or outside IR35.

Detailed Questionnaires: Uses in-depth questionnaires to cover all relevant factors like control, substitution, and mutuality of obligation.

Audit Trail:

• Documentation: Maintains a thorough audit trail of all status determinations.

• Evidence Collection: Collects and stores supporting evidence for IR35 assessments.

Risk Management:

• Risk Assessment: Helps identify and mitigate risks associated with incorrect IR35 classifications.
• Compliance and Reporting HMRC Reporting: Ensures proper reporting to HMRC.
• Regular Compliance Checks: Conducts regular checks to ensure ongoing compliance.

Expert Support:

• Professional Guidance: Provides access to expert advice on employment law and tax regulations.

• Dispute Resolution: Assists in resolving disputes related to IR35 status determinations.

IR35 doesn’t have to be intimidating, but it requires attention to detail and proper planning. By understanding the legislation, reviewing contracts, and maintaining compliance with HMRC guidelines, contractors, clients, and recruitment agencies can all navigate IR35 effectively.