What is IR35?
IR35 is a set of tax regulations designed to ensure that workers who provide services to clients through an intermediary, such as a limited company, pay the appropriate amount of tax and National Insurance contributions (NICs).
IR35 was introduced in April 2000 to stem a growing trend of employees reappearing as subcontractors. HMRC contend that if the intermediary is removed, the contractors would be exposed as 'disguised employees' that should be on the payroll. A worker is deemed "inside IR35" if they would be considered an employee of the client if they were hired directly and are subject to the same tax and NICs as an employee. If the worker is not considered an employee, they are "outside IR35".
Where a company pays a subcontractor, they avoid the need to pay Employers NIC, currently 13.8% for 2024/25, on top of their payments. The contractor can limit their tax to the corporation tax rate of 25% if they choose not to take income from the company. This compares to up to 47% that would be deducted in tax and NIC as an additional rate taxpayer.
All contractor contracts must be fundamentally sound from an IR35 perspective but must also reflect reality.
Does IR35 affect all contractors?
Yes, in the sense that all contractors need to consider IR35 and take action to protect themselves from it. However, not all contractors are caught by IR35. Whether you are caught by IR35 (or being 'inside IR35') depends on several factors. The law for tax and social security legislation does not define 'employment' and 'self-employment'. Over the years, Courts have considered the issue, and their guidance is known as IR35 case law. If you are still determining your IR35 status, it is best to seek expert IR35 advice.
Burden of responsibility
The law was changed in April 2021 so that large Companies will bear the risk of paying any tax liabilities for any contractor they take on who HMRC later deem inside IR35. However, if you are working for a small company, it is your responsibility to ensure you are not an employee. If HMRC disagrees with your conclusion, you will be liable for the tax and national insurance, including what your client would have paid if you were their employee. A company will be deemed a large company if they have at least two of the following: turnover above £10m, balance sheet above £5.1m and 50+ employees.
Companies Based outside the UK
IR35 does not extend to companies outside the UK. However, if your client has a subsidiary in the UK, it cannot get around IR35 by routing payments via a foreign entity.
Employees Versus Contractors
It can be helpful to consider the differences between the two.
An employee works for an employer under a contract and is subject to the control and direction of the employer. They are entitled to rights and benefits not afforded to contractors, including sick pay, redundancy and various equality laws. An employee will typically go to work at the same offices of the same firm every business day and will not be allowed to work for rivals. They certainly cannot send someone else to do the work! They are expected to follow the rules and procedures of the company even if they do not like them.
A contractor is someone who provides a specific service for a given fee. They often have a start and end date and may be paid to do a job rather than the number of days they worked. The contractor will make their own decisions, use their own skill and initiative to do the work and will choose where, how and when they work. They do not need training and typically bring specialist skills that the company's employees cannot provide. They may send someone else to do the work at their own expense.
Sham contracts
Unfortunately, contractor contracts are rarely ideal, and you may be asked to work at the client's offices and adhere to various rules. However, if the actual relationship is that of an employer-employee, HMRC will disregard the contract. This means that HMRC will only use a contract if it is to their advantage, so while it must be well written, it must be adhered to by both parties. If you are working for a large company, this is less of a problem as they are taking the risk of the tax bill in an investigation, but if it is a small company, you must take steps to avoid exposing yourself.
Important clauses
There are three key clauses that a contract should have:
1) You have the right to provide a substitute
The right of substitution is critical as proof of being outside IR35. You can send the client or the agent emails about this, and if you get a reply, that may prove extremely useful in an investigation. Any other proof, like letters or notes from your agent or client, would help.
2) You have full autonomy in how you work
Independent contractors should ideally be engaged to provide services the client's employees cannot do. It is therefore expected that independent contractors should be able to carry out the assignment without any training from the client, except for a reasonable induction and any health and safety briefings required
3) No mutuality of obligation
This means that you do not have to work, and they do not have to provide you with work. Open-ended engagements with no specific link to a project and moving between roles and assignments can prove that there is mutuality of obligation.
Fettered clauses
Watch out for fettered clauses. If your contract says you have the right to provide a substitute, subject to the prior approval of management, then you probably do not have the right to provide a substitute at all. For example, if your contract says you can work wherever you like, but must also be in the company office Mon-Fri 9-5, using the company computers and with the templates provided to other employees, then you do not have control at all.
Keep All the Proof
Contractors should arrange to obtain and keep certain documents to prove, as best as possible, that they are outside IR35. Keep any proof you can get that you've paid your own expenses. Not just receipts but any requests for materials needed from the client, any email asking you to pay. If the contract is long and you are working for a sole client, it would be advisable to get a lawyer to review it. Remember, the Revenue will go back six years if it decides to check your status, so you will need to save everything relevant for that time. Ensure that you get proof while the project is taking place so that you can obtain it six years later. You may find using a confirmation letter useful.
Bring Your Own Equipment
Are you using the same computers and equipment as the company employees? If you are a contractor, you should consider bringing your own.
Consider the working environment
Times have changed, but previously most employees were not permitted to work from home, so it is important that you are also able to do this. If you are in your client's office, are you taking breaks with the other staff? Would they see you as a contractor, or would they think you were an employee? You should also not wear the uniform of the company!