As a contractor, it is your responsibility to make sure you are fully compliant with IR35. It’s likely that you have heard of IR35, but do you know exactly what it means? To help you make sense of your responsibilities, we put together a guide detailing all you need to know about the legislation and how it could impact your company.

What is IR35?

IR35 is a government legislation which was established as a way to reduce tax evasion amongst workers. These workers were known as disguised employees and would operate as permanent employees but work through their own company to claim the same tax efficiencies.

How could IR35 impact you?

A contractor who is outside of IR35 would be working as a separate entity and would not be receiving the benefits that permanent employees receive. As a limited company contractor who is working outside of IR35 you are entitled to increased tax planning opportunities, which compensate for the lack of job security and other benefits.

How is my status determined?

HMRC will use a number of complex criteria to determine whether your contract is inside or outside IR35. Some of the factors they will consider are as follows:

Right of Substitution

The need for one particular person to carry out a role is an essential element of a contract of employment. It therefore follows that if a contractor has the freedom to choose whether to perform their duties themselves or to hire somebody else to do it (on a reasonably unfettered basis) for them, is self-employed.

Mutuality of Obligation

The expectation for continuous work to be provided to a person and the expectation for all work provided to be completed characterises an employment relationship. If there is a clause contained in a contract setting out an obligation for the client to offer further work and for the contractor to accept it, there would be a mutuality of obligation in the contract and it would be caught by the IR35 legislation. Rolling contracts’ or indeed contracts that are continually renewed could therefore fail this test.

Right of Control

Control concerns what has to be done, when and where it has to done and how it has to be done. In an employment relationship, each of the above is dictated to the employee, if a person maintains autonomy over these things it would indicate self-employment.

If the client can move the contractor according to their priorities or exercise significant control over how they perform their duties (through supervision, monitoring, checking and appraisal) as opposed to complete freedom over how to complete a project, then they would be seen as employed rather than self-employed.

What other factors contribute to HMRC’s decision?

The regulations that surround whether your contract falls inside or outside IR35 are extremely complex and will depend on the contract in question and your working practices. It is important to remember that HMRC can review everything to establish if you are an employee or separate director of your own company.

Here are a few other factors which HMRC will take into consideration when determining your status:

  • Employee benefits – As a contractor you are not entitled to employee benefits such as training courses, holiday and sick pay, annual staff parties and pension contributions.
  • Freedom – Are you free to work on your own or are you managed by your client? Contractors will generally work freely, whereas permanent employees are managed.
  • Financial aspects – Workers that are permanently employed by a company will very rarely be taking a financial risk to be at work. However, being a separate entity means that contractors may have to purchase their own equipment, which depending on the length and rate of the contract in question could leave you out of pocket.
  • Termination of contract – Typically permanent employees will have a notice period, but as a contractor your client will normally have the option to terminate the contract immediately if they so wish.

As a rule of thumb, any contract which strikes similarities to a full-time employee and employer is likely to be deemed inside IR35. 

What are the implications of being inside IR35?

If you are caught by the legislation then IR35 will prevent you from using traditional tax-planning techniques (small salary and high dividends) to minimise your tax obligations. Instead it will require you to pay almost all of your fee income out as a salary meaning you are taxed in the same manner as a permanent employee.

The IR35 status is determined by looking at whether the engagement would be one of employment or self-employment in the absence of the service company.

How will my take home pay be affected?

 If you’re caught inside IR35, you will be liable for full tax and National Insurance contributions as opposed to the salary and dividend structure if you’re outside. You will also need to calculate a deemed payment – this is your annual turnover minus your 5% allowance for the running costs of your company.

Need more advice?

 The rules surrounding IR35 aren’t always easy to follow, that’s why it’s important to get the best advice possible. For more insight into your status, try our free IR35 Checker. You can use HMRC’s free IR35 Checker if you need more guidance.