What is IR35?

If you’re working as a contractor or freelancer in the UK, don’t get caught out by the IR35 tax law. It aims to root out ‘disguised employees’ masquerading as contractors to avoid paying the correct tax. The law changed in April 2021, with IR35 tax rules changing for contractors working with medium and large clients in the private sector. You can find out more below.

If you’re working as a contractor or freelancer in the UK, don’t get caught out by the IR35 tax law. It aims to root out ‘disguised employees’ masquerading as contractors to avoid paying the correct tax. The law changed in April 2021, with IR35 tax rules changing for contractors working with medium and large clients in the private sector. You can find out more below.

Emily Kindness
Business insurance expert
4
minute read
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Last Updated 18 MAY 2022

How does the IR35 work?

IR35 is a piece of UK tax legislation. It’s designed to close a loophole in the tax system where workers pay less tax by classing themselves as contractors when, in all but name, they’re employees. It’s also called ‘off-payroll working’.

Let’s say an IT worker leaves a permanent job to become an IT contractor, but is then hired by the same organisation to effectively do the same role as before. Under IR35 rules, the contractor should pay broadly the same tax as an employee, unless they can show there’s no employment relationship there.

What is the difference between someone who is an employee and self-employed?

An employee works for someone else under an employment contract. Working as an employee does come with extra employment rights, compared to a contract worker. For example, they’re entitled to sick pay, redundancy pay, maternity leave etc. An employee is classified as ‘inside IR35’.

People who are self-employed are responsible for running their own business. They aren’t paid through PAYE and they don’t have the same rights as an employee would. A self-employed worker or contracted worker would be classified as ‘outside IR35’.

It is possible to be both an employee and self-employed. For example, you work a regular job during the day, but run your own business in the evenings or at the weekend.

What does inside IR35 mean?

If a contract is judged to be ‘inside IR35’, it means HMRC sees you as an employee for tax purposes. Being ‘outside IR35’ means you’re classified as self-employed.

You’ll have to pay income tax and NICs just as employees do. But that doesn’t mean you’ll also automatically be entitled to employee benefits, like holiday pay and sick pay, as tax and employment legislation are different things.

If your contract falls inside IR35, then there will likely be these requirements:

  • The contract includes details of which days and hours you work.
  • The contract states that the work is only done by you, rather than allowing you to bring in someone else instead.
  • There is an obligation for the client to offer work and for you to complete it. This is called ‘mutuality of obligation’ (MOO) and may indicate that the contract is inside IR35.

To check whether a contract falls inside or outside IR35, you can also try using HMRC’s online tool check employment status for tax (CEST). However, you shouldn’t rely on this too much as it may not always be 100% accurate in certain circumstances.

What does outside IR35 mean?

If a contract falls outside IR35, it means HMRC sees you as self-employed for tax purposes and you’re allowed to pay yourself in the most tax-efficient way. Limited company contractors typically do this through a mixture of salary and dividends. Dividends are taxed at a lower rate than income tax.

Contractors working outside IR35 need to make sure all their taxes are calculated correctly and paid on time.

Things that point to you being outside IR35 and running your own business include:

  • having your own website to advertise your services
  • owning your own equipment and office space
  • working for multiple clients at the same time.

What are the benefits of being outside IR35?

The advantage for employers in hiring self-employed workers is that they don’t have to pay employers’ National Insurance Contributions (NICs) or provide employment benefits like sick pay, paid holiday and workplace pensions.

The benefit for contractors is tax efficiency, as well as flexibility and more control over their work.

How have the IR35 rules changed?

From April 2021, the IR35 rules changed for contractors working with medium and large-sized clients in the private sector. This means many more businesses and contractors are affected by IR35 legislation.

The changes were due to come into force on 6 April 2020 but were delayed because of the coronavirus pandemic.

From April 2021, private sector employers are responsible for deciding whether IR35 applies to any contractor they hire. This brings them in line with employers in the public sector.

Small businesses aren't affected by the IR35 changes so, if you work for a small client, the onus will still be on you to work out whether IR35 applies to you or not.

If you get it wrong, you face being fined by HMRC and having to pay back missing tax.

Why were there changes to IR35 legislation?

While IR35 legislation was introduced in 1999, contractors were able to choose whether they fell under that legislation. This was an issue, because it was easy for them to decide they didn’t and therefore didn’t have to pay the tax they should be paying.

HMRC estimated that only 10% of individuals, who should comply with the legislation, classed themselves as inside IR35. The HMRC estimated that, by setting their own IR35 status, contractors would avoid £1.3 billion in taxes each year, by 2022/23.

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