Tax Advice
What Is IR35? Here’s What You Need to Know
If your business hires contractors or off-payroll workers in any capacity, you need to know about the IR35 rules.
New IR35 rules came into effect in April 2021. This shifts the responsibility for identifying workers’ employment status onto private businesses. Up until then, this liability was met by the intermediary company. But now it’s up to you.
This is notoriously tricky legislation because its definitions lack clarity. This complexity has worked against HMRC in recent IR35 cases against some high-profile U.K. taxpayers.
But you must make sure you’ve done all you can to be compliant with these new, changing regulations. And here’s where you start.
What Is the IR35 Legislation?
IR35 has become the nickname for HMRC’s ‘off-payroll working’ rules that are part of the Finance Act. The original press release outlining the details was called IR35.
It’s sometimes called ‘intermediaries legislation’ because it involves an employer hiring a worker through a third party. HMRC’s aim is to uncover ‘disguised’ employees. People who are avoiding tax by working through a third-party company when they would otherwise be considered employees. The tax difference between the 2 results in significant losses to the Treasury.
The idea of the IR35 rules is to “make sure that workers, who would be classed as an employee if they were contracted directly, pay broadly the same Income Tax and National Insurance contributions as employees.”
We’ve got a more detailed explanation of IR35 origins and rationale here. Let’s get to the practicalities you need to know now.
How Is My Business Affected by the Off-Payroll Working Rules?
There are 3 parties involved in this type of working arrangement, and they’re all affected by the off-payroll working rules.
- Client: This is you—the business getting a service provided by a worker through an intermediary. Sometimes referred to as end clients.
- Worker: The person delivering the service. They might be called a contractor, freelancer, or off-payroll worker.
- Employment intermediary: Any third party that’s supplying the worker. This might be a personal service company (PSC), agency, limited company, or limited liability partnership.
Basically, you pay the third party, the worker does the job, and the intermediary (usually their own limited company) pays them.
We’re focusing on you in the client role in this article. If you’re also in another part of this business relationship triangle, you need to check out those specific rules.
Quick Definition: Personal Service Company
If you’re already familiar with this term, skip to the next section! If not, it’s a key factor in this legislation, so worth a quick read.
A personal service company is a legal business construct. Usually, an individual establishes their own PSC and provides their own services to businesses through that limited company.
A business pays the PSC for the services of the individual and the individual is paid by the PSC. It’s possible for personal service companies to involve more than 1 individual.
Why add this extra layer of admin? Because there are benefits for both the individual and the hiring business.
Personal service companies are good for the individual worker because limited liability status gives them financial protection. It also means that they don’t have to pay employees National Insurance contributions (NICs) or income tax. Having their own limited company means that they have the flexibility to be more tax-efficient by deciding how to draw profits from the company.
PSCs are good for the hiring business because it means they don’t have to meet the usual employee obligations. No sick pay, holiday pay, maternity pay, or employer’s National Insurance contributions at 13.8% to pay. And no deducting tax through PAYE. That’s a substantial tax and National Insurance saving for the business.
It doesn’t mean that the individual worker doesn’t pay tax at all. They pay corporation tax on the profits of their own limited company and income tax on any salary they take over their personal allowance. And it’s why perfectly legitimate work happens this way every day.
But HMRC wants the off-payroll legislation to remove the misuse of PSCs as a tax avoidance strategy. Disguised employment reduces tax and National Insurance yield, and leaves workers without the employment rights they’re entitled to.
When Do the (IR35) Off-Payroll Working Rules Apply?
The off-payroll working rules may apply when you have workers who provide their services through an intermediary. This will usually be their own personal services company, but can also be a limited company, partnership, or employment agency.
The key to whether the rules apply is if the worker would be considered an employee if they weren’t being engaged through a third-party company.
And this is where the waters can get very muddy.
There is no specific checklist to determine employment status. And that’s what IR35 cases hinge on. Would the worker be classed as an employee if there was no third party involved? Are they a genuine contractor that’s self-employed? Are their actual working practices more like a permanent employee?
These Decisions Are Based on 3 Key Factors
1. Who’s in Control?
If you are largely directing and supervising how, where, and when a worker completes their job, it’s likely that the off-payroll rules will apply. To be truly ‘outside IR35’, workers have freedom over how they fulfil their contract.
2. Bring On a Substitute
If your worker is able to send someone else to do the agreed work, then this demonstrates self-employment.
3. MOO
Nothing to do with cows, unfortunately. MOO stands for the official term ‘mutuality of obligation’. It means that you are bound to offer more work once the current contract is over, and the worker is obliged to take it. This is a key indicator of being ‘inside IR35’ because it’s just like an employment contract.
The opposite, ‘outside IR35’ situation is where work is completed on a project-by-project basis, and the worker is under no obligation to undertake future work. Without MOO, your contractors are free to work with more than 1 client simultaneously. Another determining factor of self-employment is the absence of an exclusivity clause.
Some Other Factors to Consider Are…
- Paying workers by project or in a sequence of milestones during a long project shows that they’re working outside IR35
- If your contractors have their own professional insurance and have some responsibility to sort out mistakes at their own cost, this supports a determination of self-employed status
- If you provide all the equipment to the worker, this may be taken as an indication that they’re a ‘disguised employee’
To remain outside the off-payroll tax rules, your workers need to be able to show that they’re ‘in business on their own account’. This phrase has been used in the final judgement in recent rulings found against HMRC. Evidence to support this position includes all the same business essentials you use. For example, an office area, equipment, website, and employees of their own.
Why Do I Need to Know How to Define My Workers’ IR35 Status?
On 6th April 2021, the responsibility for applying the off-payroll rules in the private sector changed from being with the intermediary company to the hiring business—you. This brings them in line with public sector organisations.
If you’re a medium-sized or large business, you are now liable for working out each contractor’s employment status and paying the correct PAYE income tax and employers’ National Insurance contributions.
Small businesses are exempt from this IR35 status responsibility. It remains with the intermediary company.
A smaller private sector business is defined as a company that has met 2 of these 3 eligibility criteria for 2 consecutive tax years:
- Maximum 50 employees
- Annual turnover up to £10.2 million
- No more than £5.1 million on your balance sheet
If you’re over these thresholds, then you’re in the medium-sized or large private-sector business category and have IR35 liability.
What’s an ‘IR35 Status Determination Statement’?
As an employer with responsibility for determining your contractors’ employment status, you must give all PSC contractors and the intermediary company a status determination statement. This must be done at the start of a working relationship and explains your IR35 status determination.
HMRC’s Check Employment Status for Tax (CEST) online tool is a really useful place to start tackling this process. CEST helps you think through each of the following aspects of your new contractor’s working situation:
- Details of the contract
- The worker’s responsibilities
- Who decides what work needs to be done
- Who decides when, where, and how the work is done
- How the worker will be paid
- If the engagement includes any corporate benefits or reimbursement for expenses
Some aspects, like MOO, aren’t included in this tool. So you’re encouraged to also use your own discretion.
Another positive of using CEST is that it’s one of the indicators that you’ve “taken reasonable care” when making your decision. And this is important. Because if you’re subject to an HMRC investigation and found to not have ‘taken reasonable care’, you’ll be liable for tax and National Insurance deductions and any applicable apprenticeship levy.
Once you’ve worked through CEST and taken any other IR35 factors into consideration, you must decide their employment tax status. Complete a status determination statement to share your IR35 status decision with your worker and the intermediary company.
Getting Started With IR35
If this is all new to you, it may feel a bit overwhelming. The rules lack clarity and simplicity—there’s no getting away from that. And a certain level of stress accompanies any new legal liability. So let’s break it down into more manageable steps with key questions.
- Read FreshBooks’ other IR35 information to get familiar with the language and definitions. Have a go at using CEST. Use HMRC’s resources to bulk out your knowledge further. Who else needs training? Do you want outside professional advice?
- Sort out the practicalities. Who’s responsible for making this decision in your company? How are your IR35 records going to look and where are they kept? How are you building this IR35 decision into your existing onboarding process? What does your IR35 checklist contain? Do you meet the ‘reasonable care’ standards?
- Prepare your status determination statement.
- Decide on an appeals procedure if your worker or the intermediary company disagrees with your decision.
You need to invest some thinking time setting up your compliance for IR35. But once you’ve got a system in place, things will seem much more doable. With a clear pathway through your due diligence, you can be confident that you’re meeting your full legal responsibilities. And you can always tweak it as you go along.
Remember, only medium-sized and large businesses are responsible for applying the off-payroll rules.
This post was updated in January 2024.