The Ultimate IR35 Guide
IR35 is a term which is causing a lot of confusion, no matter what industry you’re working in.
Recent changes to how the law covers the private sector has created a buzz of confusion in much the same manner as when changes in 2016 saw many public bodies have to adapt to new tax rules quickly.
The Empiric team have been working with clients involved at every step of the IR35 cycle. We help contractors and clients who don’t know what designations they fall under. We also work with agencies which all of a sudden may find themselves in charge of taxes and insurance.
In this IR35 guide, we want to provide a comprehensive handbook of information for anyone and everyone who will be affected by IR35’s new iterations. We’ll be looking at key elements of IR35 before diving into specific changes you should know about, as well as how it impacts contractors within key industries across the UK and abroad.
IR35 guide contents
- What is IR35?
- What IR35? stand for
- How is IR35 Changing
- What Does IR35 Mean For Employers
- What Does IR35 Mean For Freelancers
- What Does IR35 Compliant Mean
- IR35; Inside or Outside?
- IR35 In Private Sector
- Am I IR35 Exempt?
- When Is IR35 Coming Into Effect?
- Can IR35 Be Backdated?
- Does IR35 Apply To Me?
- IR35 & Overseas Clients
- IR35 Advice
What is IR35?
In the simplest definition of the term, IR35 is a tax law.
In a broader sense, IR35 is a tax law which has been introduced to combat tax avoidance in instances where workers are supplying their services to clients indirectly.
When we say indirectly, we’re referring to the use of an intermediary (e.g. an LLC) when, in fact, a worker is pretty much doing the same work as an employee of said firm. (You can get more key information in bite-size form by visiting our What is IR35 page.)
The difficulty for many lies on designation of IR35 and where the individual stands when working through such a capacity. HMRC wants you to deem whether you fall inside or outside of IR35. Someone on the inside would be expected to pay the correct tax in line with the company, who would have to do the work to figure this out. Someone on the outside would be considered wholly self-employed and have to calculate tax themselves (usually via their accountant).
Designation is the area currently confusing many people operating as an LLC, and headaches for businesses who previously wouldn’t have had to worry about arranging their contractor’s tax calculations.
Even though it does sound like it makes things easier for contractors (after all, you wouldn’t have to spend time sorting taxes out) it takes away a level of control that previously helped in some instances to pay less tax.
What Does IR35 Stand For?
IR35 may be new to many people trying to get their head around it but one look at its name, and you’ll immediately be able to tell it has been around for quite a while.
The IR in IR35 refers to Inland Revenue. IR35 was introduced in the 1999 budget and became a law when the new tax year started in 2000. Inland Revenue merged with HMRC in 2005, but the IR stuck.
As for the 35, this isn’t some sort of tax code, but refers to the press release number for the news; a standard practice at the time.
Why is IR35 Changing?
Even though IR35 has been law since 2000, it is a tax law which has (for lack of a better phrase) morphed and grown legs over the last two decades.
As the new tax year approaches, IR35 is causing significant changes that many companies and individuals aren’t happy with or are having trouble adjusting to.
Initially, Inland Revenue created IR35 to curb tax avoidance by individuals believed to be gaming the system. In most instances, this was done when someone became a personal service company to their own business.
An example of this would be where someone “leaves” their job on a Friday, but comes back the following Monday under contract as a personal service company.
That person could then have their now former employer pay all their wages in one or two months, without paying the rest of the year, to hit the cap on National Insurance and not need to pay it for the rest of the year.
It was mostly a way of juking and jiving Inland Revenue/HMRC to avoid paying taxes, and that is something HMRC wanted to change.
How is IR35 Changing
We already mentioned how IR35 is looking to see when someone is inside or outside IR35. After becoming law in 2000, there have been small changes here and there to tighten up a law that at its core was loose by definition.
The main changes have revolved around the opportunity for HMRC to claim more National Insurance and income tax. In the mid-2000s, the taxman didn't see returns on IR35 that it wanted (an FOI request around the time estimated IR35 had pulled in under £10m over four years when it was supposedly going to generate the Government at least £80 million per year).
The first real change happened in 2017 when IR35 was introduced in the public sector; putting the responsibility of employment status in the hands of the public employer and not the contractor. In this scenario, a contractor lost some degree of control over their taxes as the public company employing them now had to match taxes to be roughly in line with employees of the company.
The second big change implemented the same level of measures upon the private sector to medium and large companies, with a start date of 6th April 2020 (when the tax year begins).
This flip in responsibility is supposed to do two things:
- take the pressure off contractors to do tax work
- help HMRC get a better look at taxes and crackdown on non-compliance from contractors who should be taxed more.
In reality, the recent change has created more pressure for contractors and private employers, who have suddenly gone from having taxes on the sidelines, to IR35 being a sticking point front and centre.
In the next section, we’re going to break down what the change means for employers and freelancers.
What Does IR35 Mean For Employers?
The new changes in IR35 are causing employers headaches, in large part due to now having a range of responsibilities put upon them which they never asked for or wanted.
Previously, the designation for taxes was in the hands of the contractor. For example, if I run a large business and hire you to carry out work, I’m leaving it up to you to get National Insurance, taxes etc. all sorted out in the hopes the contractor will comply with what HMRC wants to see.
Now though, an employer has to be the one to say “oh, this person should be paying X amount in taxes based on how they work for my company”. It sounds simple enough, but many large businesses in the UK hire thousands of people as contractors. That’s thousands of people which every business now has to check falls in line with regulation meticulously, and that means having to create new jobs.
An employer doesn’t want to have to hire scores of people for new roles on a rule they never asked for. In many cases, companies would now choose to not hire a contractor to avoid the hassle. This is causing many contractors across the UK to panic.
What Does IR35 Mean For Freelancers?
On paper, the changes in IR35 would seem like a winner for any freelancer.
You no longer have to worry about finding an accountant, and you don’t need to worry about deductions for National Insurance or Income Tax as the client is sorting all that out.
In reality, the changes in IR35 would predominantly see contractors take home less money. Adjustments in paying Corporation Tax (which would fall dramatically) would see a contractor’s Income Tax go up, as well as now having to pay National Insurance (it is usually £0 outside IR35).
The most important thing for freelancers is to now get a good knowledge of whether any existing and future contracts all fall in line with HMRC’s Check Employment Status for Tax Tool, more commonly referred to as CEST.
You may have seen some news stories surrounding CEST, especially with an increase in IR35 tribunals of freelancers having to go to court to fight over their employment designation.
In these cases, IR35 gets very murky as the laws are subjective and can work against freelancers in instances where work is:
- done on a verbal agreement
- there is no termination clause
- contracts lack evidence of a right to substitute
There are now examples, after going to tribunal, highlighting just how confusing things can get for freelancers. There have been cases that highlight as such, with one prime example being a urologist (George Mantides Ltd v HMRC) working on a locum basis for two different hospitals. The urologist did the same job in two locations for two separate NHS Trusts. He had a contract in place with one hospital and a verbal agreement with another. The tribunal found he was both inside and outside IR35 and would have to pay back a lot of taxes.
Same job. The same type of business. Completely different outcomes, and all because the individual wasn’t fully compliant.
HMRC wants freelancers to be transparent about existing and previous contracts so that they are taxed accordingly. And that means you need to be compliant.
What Does IR35 Compliant Mean?
Becoming IR35 compliant looks complicated at face value, but once you have an understanding of the foundations, it is easy enough to get yourself clued in with the basics and avoid confusion down the line. It all comes down to knowing who determines IR35 status, who pays employment taxes and what to do when an agency is used to facilitate work between the contractor and end client.
From the perspective of a business, IR35 compliance starts by confirming that your contractor definitely falls inside or outside IR35 based on employment status. If the company has hired the contractor themselves, they need to pay taxes to HMRC (this differs when an agency is used).
From the perspective of the contractor, IR35 compliance is merely ensuring that any and all information relating to tax contributions and salaries is made available to the employer and HMRC if they want to check for themselves.
From the perspective of an agency, compliance falls between themselves and the business. The business would have to determine IR35 as they are designating employment status and not the agency. When a contractor is inside IR35 (effectively part of the company for said work), the agency has to comply by paying taxes for both sides and then paying the contractor their wages, be that as salary or a dividend after deductions.
If you’re unsure about compliance and want to avoid creating problems with how you handle IR35, Empiric provides IR35 solutions for businesses and individuals.
IR35; Inside or Outside?
Are you in or out? It’s the question that is asked the most when looking at IR35.
It should be easy, and pretty much is, but people may find themselves getting confused by overcomplicating IR35 designation.
To keep things clear, it is best to think of IR35 status as such:
The contractor’s work is pretty much the same as a company employee, and the business can control the workload.
For all intent’s purposes, if a contractor is doing work in the same manner as an employee, or the contract they’re working off is pretty much the same as a contract an employee would sign, they should be thought of as working INSIDE IR35.
The contractor’s work is in their own hands at all time, and the company who hires them doesn’t have control.
If a contractor can work however they please, have the right to terminate, or can easily substitute in someone else on their behalf without the company having to worry or complain about it, it’s safe to deem the contractor as working OUTSIDE IR35.
IR35 In Private Sector
The Public sector was where the first significant changes in IR35 came about when announced in the 2016 Autumn Budget.
At the time, when a public body wanted to hire a contractor for work, they had no responsibility in deciding the contractor’s tax status. This meant that someone hired by an organisation like the NHS, the Government or a publicly funded media company (BBC) could decide their tax status.
It created an advantageous position for contractors that could see them save a lot of money on taxes while effectively working for a public body in the same capacity as an employee. Instances like these are sometimes referred to as “disguised employment”.
By shifting the responsibility, HMRC placed it on the employer/end client who would have to apply taxes responsibly and ensure a contractor gets paid accordingly.
With the 2020 changes, the public sector remains as is.
IR35 In Private Sector
The 2020 changes really only affect those in the private sector, as it brings legislation in line with public bodies.
You’ve seen throughout this article the many tax conundrums private companies are facing. The biggest change is a direct result of designation. With medium to large private companies having to decide whether a contractor is inside IR35, they need to have more resource in place.
It isn’t merely a case of declaring their contractor’s status. Companies now have to employ staff, who will have to clearly show HMRC all the boxes have been ticked, and due diligence has been carried out. New rules will mostly take the form of a status determination statement and evidence that the CEST tool was used.
The shift also means that clients suddenly have to take on more liability for fees, so while staff are getting status declarations in order, even if both parties know the contractor will be outside IR35, they have to be seen as inside.
To help minimise your level of risk and liability, you may want to look at some of the IR35 solutions we provide clients.
Am I IR35 Exempt?
It might feel like IR35 is impacting everyone, but there are some contractors out there who may not know they’re eligible for exemption. In most cases, this will be because their end-client (the company they work for) is considered a small business.
The Companies Act 2006 put into place some significant points in defining what a small business is, and how this applies when figuring out IR35.
General markers to see if the end client is outside IR35 would include:
- The client has under 50 employees
- Turnover is under £10.2 million
- The balance sheet is under £5.1 million
If the contractor’s client matches these, then it is presumed they’re working for a small company and don’t need to worry about being inside IR35.
However, there are some cases where large companies will create subsidiaries to hire contractors as they’ll automatically hit criteria. If this happens to your company, it’s crucial to know HMRC will view the parent company as the end-client and IR35 applies.
When Is IR35 Coming Into Effect?
At the time of writing, the changes for IR35 has been postponed from the original effective date of 6th April 2020.
Any medium to large businesses and charities previously exempt from IR35 must now follow the law too. The Government have released their official response in a recent review of the law but haven’t changed much.
HMRC did suggest that the first year of the change will be regarded as something akin to a soft launch, with what they call a “light touch” approach to handing out penalties in the first year.
Will IR35 Be Delayed?
A lot of larger businesses have a rigid architecture in place, and updating IR35 can have a knock-on effect for significant portions of the workforce.
Many industry leaders have asked for IR35 to be delayed until at least 2021. The new changes are seen as a rush job, and the Government hasn’t given large companies enough time to figure out what they should be doing.
Until recently, IR35 rules meant that payments made on or after 6th April all counted, no matter when work was carried out. This has been changed though in the lead-up.
Any minor change will affect your business, and we recommend you learn how IR35 will affect you.
Will IR35 Be Scrapped?
While there are plenty of opinions out there on whether IR35 should be scrapped, IR35 won’t be going away anytime soon.
Remember that this specific tax law was created to stop individuals from skirting around and avoiding tax wherever they can. Only over time has it grown to cover companies too.
Can IR35 Be Backdated?
The biggest worry for many people with the new changes has been whether HMRC is going to surprise everyone by saying that IR35 can be backdated. Most people will be happy to know that IR35 will not automatically apply in a retrospective manner.
So when isn’t it automatic? For those who fall foul of the rules and are suspected by HMRC of acting fraudulently, IR35 will apply when an enquiry has to be carried out.
Does IR35 Apply To Me?
IR35 affects everyone differently. It all depends on which side of a contract you’re on, as well as your industry. Here at Empiric, we’re helping those in sectors like business, building, health and hospitality figure out how IR35 applies to them. We can even help agencies caught up in the middle who are having a hard time keeping track of changes between parties.
While we do have information on how IR35 will affect you, it is essential to know if there are nuances within your niche to keep an eye on. Here are some of the main IR35 pointers for areas affected most by the recent changes:
IR35 for Contractors
Aside from large companies, contractors will be affected the most by IR35. With status determination out of their hands, it can be a difference of £1000s on every contract.
Contracts need to meet criteria which satisfy HRMC, clearly state in what manner a contractor should be considered (i.e. whether they want to be inside or outside IR35) and ensure that they genuinely act upon what a contract says.
HMRC is taking it easy in the first year the new IR35 rules come into place but expect them to go after contractors they believe are setting up contracts with language that fits the bills but isn’t at all how they’re carrying out works.
IR35 for Sole Traders
Sole traders can breathe a sigh of relief as they should not be affected by IR35, although there are some red flags to be aware of.
The law was made to apply to incorporated businesses and individuals who operate as a personal service company (PSC). Some sole traders may get contract work for a company via an agency, where the agency should know what designation to place an individual under.
For example, a sole trader may have their supervision, direction and control (SDC) controlled by the client. Therefore their agency would have to place the worker on payroll and tax accordingly.
Because some companies don’t like this (remember they don’t want contractors inside IR35), it’s the reason why many sole traders decide to set themselves up as PSCs.
Ironically, it is now those same PSCs which are having to adjust to IR35.
IR35 for Doctors
Many doctors, especially those in private health care, will set themselves up as a PSC to pay less tax when taking on extra work. IR35 leaves the designation in the hands of the NHS Trust/ Health Board employing the doctor for a set period.
As doctors have to work based on what their clients say and carry it out themselves (a doctor obviously cannot take a shift and then get someone in their place), you would think they fall inside IR35, as it demonstrates Control and Personal Service. This can depend though on aspects like PAYE or direct engagement arrangements with a trust.
Many doctors will find it most comfortable to become part of an agency, rather than become a PSC, to get paid and have the agency look after all the tax work.
IR35 for Agencies
Although much hasn’t been said of agencies, there’s a good case to be made that they will be affected the most by the change in the law.
Many recruitment agencies are having to rethink and upend processes, especially when it comes to areas like off-payroll rules, what the status of their clients (the contractors) is and whether their end clients are now considered a small or large business.
That doesn’t include figuring out what to do with current contracts that started before April 2020 which extend beyond that, or if contractors now need to be paid differently.
IR35 for Small Business
This has been mentioned further up in this guide, but IR35 has given clear ideas on what HMRC deems a small business on the client end, with criteria surrounding turnover, profits and employee numbers.
When working for a small business, the responsibilities for taxes rest with the contractor or the agency acting as the middle man.
IR35 for Drivers
IR35 will have a massive impact on drivers across the UK, especially those who have set themselves up as a PSC and get work through an agency.
In many instances, existing contracts for drivers (especially lorry drivers) may see them using company vehicles to carry out work while lacking a substitution clause in their contracts. In the eyes of HMRC, the contracted driver would be viewed exactly the same as an employee, be categorised as inside IR35 and have to be paid via PAYE.
A lot of delivery and haulage firms will also have to cover the cost for drivers on PAYE; something they don’t want to pay. This opens the doors for firms to disengage with contractors and opt for drivers who will work on a temp basis instead to avoid IR35.
If you’re running a company which employs drivers or have a delivery firm and aren’t sure how IR35 affects your business, please contact us.
IR35 & Overseas Clients
One area the changes in IR35 didn’t clearly address was what to do when a contractor (or their agency) gets work with a client based overseas.
If the client isn’t based in the UK, does IR35 even apply? If it does, who is IR35 reliant upon?
It was something no one prepared for; even the Government hadn’t thought about it.
It can get very confusing, and we do recommend talking with a specialist if this is the case for your business. As a general rule of thumb, if the end client (and the agency) you’re doing work for is based outside the UK, they are still partially responsible for designating which side of IR35 a contractor falls on.
There are also variables which need to be looked at, including:
- where services are provided
- if the client has a presence in the UK
- the workers on the contract are from the UK.
IR35 is supposed to be a simple tax law that should see everyone paying their equal share.
What started as a simple law in 2000 has reached a stage where even those with a good grasp of the subject need details scrutinised and checked to make sure they’re compliant.
If there are any elements in this guide that you’d like IR35 specialists to look into, please don’t hesitate to get in touch with us directly here at Empiric.
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Please get in touch with us today and we can work with you to provide a IR35 solution. Although smaller companies may find they’re exempt to the change, we do recommend for anyone running a company in the private sector to contact us now.