If you’ve ever been a contractor or hired a contractor using a Limited Company (sole traders needn’t worry… yet), chances are the word ‘IR35’ brings you a great deal of confusion and stress.
Whilst it’s a welcome relief for many that the IR35 reforms have been delayed until April 2021, this doesn’t mean it’s gone away altogether.
Here’s our overview of the IR35 situation.
It’s complicated. It affects many thousands of self-employed people here in the UK. The consequences of putting a foot wrong are high, as the government is seeking to clamp down on tax avoidance in this area. What’s more, it’s a (slowly) shifting landscape.
So we wanted to take the time to explain everything you need to know. (Keep in mind that when we talk about the changes coming into effect, we’re talking about April 2021. You’ve got a good long while to prepare!)
In this article, you’ll find:
- What is IR35?
- Who’s affected by this legislation?
- What does it mean to be working ‘outside’ of IR35?
- What does it mean to be working ‘inside’ of IR35?
- How do I know if I’m ‘inside’ or ‘outside’?
What is IR35 and why does it exist?
IR35 is a set of tax laws that were introduced by Gordon Brown in 2000. (The ‘IR’ stands for Inland Revenue, the old name for HMRC.)
The legislation was designed to close a loophole in the tax system that meant workers could use a Limited Company setup to pay less tax.
It looks at the reality of your working relationship with your client. Are you genuinely behaving like an external service provider, or do you actually have more of an employer<>employee relationship with your client?
The latter would make you a ‘deemed employee’ or ‘disguised employee’. And in the eyes of the legal eagles, that is not a good thing.
Basically, if you’re behaving like an employee, the government wants you and your client to be taxed as if you were an employee.
The idea that underpins all of this is that employees enjoy benefits that Limited Companies don’t - stability, equipment, sick pay and so on - and should therefore pay more income tax and NICs (National Insurance Contributions). And the employer has to pay more tax on their side too, compared to hiring a contractor.
What’s the practical situation with IR35 today?
Whether you’re halfway through an engagement or about to take on a new contract (or any other kind of self-employed assignment), you need to know two things:
- Are you affected by the IR35 legislation in the first place?
- If so, do you fall ‘inside’ or ‘outside’ of IR35?
(More on both of those points below.)
Currently it’s your responsibility to decide if your Limited Company should fall ‘inside’ or ‘outside’ IR35. In April 2021, the responsibility may switch over to your end client, depending on the size of the company.
An easy starting point is simply to ask how your end client sees their engagement with you (or the agency your end client uses for their contractors, if they use one - in other words, the person or organisation that pays your invoices) and take it from there.
If you’re ‘outside IR35’, happy days, it’s business as usual. But if you’re ‘inside’, you’ll need to make some adjustments.
Worried that you might be under the wrong IR35 determination? We recommend you speak with an accountant to ensure you get the best advice.
Who is affected by this legislation?
If you’re a PSC Limited Company, you’re affected.
Let’s unpack that:
A Limited Company is a business structure where the company has its own legal identity, separate from its shareholders and directors.
PSC stands for Personal Service Company. Put the two together, and the phrase ‘PSC Limited Company’ is used to describe a business that’s owned and operated by a self-employed person who set it up so they can sell their work on as an individual (unlike businesses that manufacture physical goods, for instance).
Freelancers and consultants are often classed as PSC Limited Companies. Even if you don’t personally identify as one, HMRC might still view you as one.
It all comes down to whether you fall inside or outside the IR35 legislation. These are two different IR35 statuses that the government uses to classify workers.
What does it mean to be working ‘outside’ of IR35
First the good news. If HMRC considers your self-employed engagement as a PSC Limited Company to fall outside of IR35 regulations, it means they’re happy that you’re operating a genuine business and wouldn’t be deemed an employee for tax purposes.
You will be able to pay yourself a salary and draw the remainder of income as dividends from your Limited Company. You remain responsible for paying all your own taxes.
What does it mean to be working ‘inside’ of IR35
If HMRC considers your engagement to fall inside of IR35, this means you’ll be considered an employee of your end client and should therefore be paying tax as if you were an employee.
Being caught inside of IR35 isn’t necessarily a problem. It just means you’ll need to ensure you are paying the right taxes at the right time.
You also need to make sure you’re 100% clear about the implications on your business finances and your relationship with your client.
If your IR35 status with a current client changes from ‘outside’ to ‘inside’, you have 3 options:
- Do nothing and pay more tax (estimated to be around 25%)
- Renegotiate your contract (increase your daily rate to negate the effect of IR35)
- Leave and start afresh somewhere else (we go into more detail about this further down)
This is definitely a topic to pick up with your accountant.
How do I know if I'm inside or outside of IR35?
The short answer is that if you feel like an employee, not an independent service provider, you’re probably inside IR35 and could fall foul of the legislation. No need to panic, but now’s the time to get professional advice and put things right.
Here’s the long answer:
If you work in the public sector, your end client is responsible for determining your IR35 status, so any issues and consequences are mainly theirs to deal with.
But if you work in the private sector, currently you’re the one who’s responsible for determining your IR35 status. (This is due to change in April 2021)
There’s a range of determiners that HMRC use to decide about your IR35 status, and these can also help you figure it out yourself before it gets to that stage. Generally, they cluster around the agreements you have in place with your client and the way your work is actually carried out.
Some of the main ones are:
- A written contract. As a by-the-book PSC Limited Company, ideally you’ll have a contract in place laying out the terms of the engagement to show that you’re not a disguised employee. If you don’t have a contract in place, HMRC will have to go entirely off your working practices to decide if you’re inside or outside IR35.
- Working practices. For example, are you sticking to a set schedule which was laid out by your client and is also followed by employees at the company? Do you go to staff events? Are you using the company’s office equipment? You might fall inside IR35.
- Right of substitution. Will your client let you send another worker instead of you if you’re not available? If so, you’re less likely to fall inside IR35.
- Control. How much autonomy do you have in scoping out, planning and delivering your work? Do you (broadly) get to call the shots, or are you told to do things the way everyone else at the company does them? No prizes for guessing which of those is the hallmark of a disguised employee…
- Mutuality of obligation (MOO). This is the obligation of the company to provide work and the obligation of the worker to accept it. It applies in an employee-employer scenario but shouldn’t apply to a PSC Limited Company. In other words, if you turn up one day and there’s nothing for you to do, your client should be able to send you home. Likewise you should have a high degree of control about what you say yes or no to.
- Financial risk. Is your situation more volatile than an employee’s would be? For example, are your invoices paid weeks or months after the work is completed? If so, that suggests you’re outside IR35.
- Right of dismissal. Have you and your client got an agreement in place which prevents the engagement from being terminated at short notice? If so, there’s a chance HMRC would classify you as a disguised employee.
- Part and parcel of the organisation. More IR35 jargon, geared around whether you’re integrated with your client or properly independent. Do you have your own company phone and business cards? Do you pay for your own training? Got more than one client on the go? These are signs that you’re independent.
- Intention of the two parties. Are you doing predictable work with your client for the mid to long term? Would an outside observer struggle to spot the difference between you and an employee? There’s no easy way around this… you’re probably a disguised employee.
Check with the professionals around you. Consult with your accountant as they should be highly experienced and knowledgeable around IR35 and all the considerations needed. If you feel like you need further protection there is also tax investigation insurance. This will provide you with the cover and security from an HMRC investigation but do check policy specifics as to what they would cover.
Give the government’s CEST tool a go (Check Employment Status and Tax). This is an online form that will guide you through some questions to help you work out which side of the line you fall.
For self-employed solidarity from other Coconut customers who are facing the same challenges as you, head over to our Coconut Bite forum. And we’ll do our best to answer your questions too.