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.

Our guide explains IR35 in simple terms and looks at what the new IR35 rules mean for you.

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.

Our guide explains IR35 in simple terms and looks at what the new IR35 rules mean for you.

Emily Kindness
From the Business team
3
minute read
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Posted 8 FEBRUARY 2021

What is IR35?

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’.

HMRC introduced IR35 regulations in 2000 to combat the issue of ‘disguised’ employment. Many contractors operate as limited companies to take advantage of the tax benefits, and most do so legitimately. But there’s sometimes a grey area between what a limited company contractor and an employee is.

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.

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.

What are the IR35 tax changes?

In April 2021, the IR35 rules are set to change for contractors working with medium and large-sized clients in the private sector. This means many more businesses and contractors will be 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 will be responsible for deciding whether IR35 applies to any contractor they hire. This will bring them in line with employers in the public sector.

In the meantime, if you’re a contractor working with a client in the private sector, it’s still down to you to work out your IR35 status. Small businesses won’t be 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.

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.

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.

To work out whether a contract falls inside IR35, there’s a few things to consider:

  • Does the contract state which days you work and the times you start and finish? If so, it implies employment.
  • Does the contract require that the work is only done by you, rather than allowing you to bring in someone else instead? If the work has to be done by you, it’s likely to fall inside IR35.
  • Is there 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.

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