What is IR35 and how can I protect myself from it?

If you’re a client that hires contractors, or a contractor or freelancer working through your own limited company in the UK then you need to be aware of the new off-payroll rules or ‘IR35’, as it can have a big impact on payments, tax and national insurance.

New IR35 legislation is designed to crack down on disguised employment by reclaiming what HMRC sees as lost tax and national insurance contributions. The Treasury expects the IR35 legislation to net approx £1.1billion in the first year alone.

At the moment, HMRC can check at any time for ‘disguised employment’, and if they decide that IR35 does apply, monthly payroll taxes and employee national insurance will need to be paid, but without any of the protections & benefits an employee might expect. Contactors with a limited company who do paid work for a client need to decide if the work they are are doing is inside or outside IR35, but from April, that decision and the responsibility to pay tax and insurance will move to the end client.

The government has some draft legislation on gov.uk but there is still a lack of clarity on how IR35 status will be determined, with various contributing factors. The government maintains that the self-employed won't be affected, and that the new legislation is merely an anti-avoidance measure.

Recent IR35 news

  • 13 Dec
    13 Dec
    With the conservatives winning a huge majority, and a new budget planned from Feb/Mar 2020 it may be too late for businesses to wait for better IR35 news...Read More
    Conservative promises for a vague 'IR35 review' will be called into question in the next days and months as the April 2020 deadline looms on the horizon
  • 28 Nov
    28 Nov
    The SNP are the latest party to include IR35 in their manifesto, promising a "review of the tax rules around intermediaries also known as the IR35 tax rule", they join Labour and the LibDems...Read More
    Pressure is mounting on the Tories to review IR35 and get the self-employed vote, with other major parties pushing for a review
  • 21 Nov
    21 Nov
    The liberal democrats have pledged to review IR35 and abandon the Loan Charge should they come into power following next month’s General Election...Read More
    With the general election approaching, IR35 is still very much up for debate in the UK

How can I protect myself from IR35?

What happens on 6 April 2020?

  • Businesses (end-client or agencies) will be responsible for assessing contractor employment status
  • The smallest 1.5 million businesses won’t be affected, but medium & large businesses need to decide whether IR35 rules apply to any engagements with individuals via their limited company
  • If it is determined that IR35 does apply, the business, agency or third party that pays the individual’s limited company will need to deduct income tax & employee NICs and pay employer NICs

How does an HMRC investigation work?

  • HMRC can investigate the assignment at any time, and those investigations can be both time consuming and costly. Affected contractors can get insurance but that is likely to be expensive
  • HMRC can evaluate contracts up to six years in the past to see where legislation should have applied & can require affected parties to remediate
  • Any future earnings may be materially reduced as a result of HMRC’s ruling
  • HMRC have the resources for a lengthy legal battle but do you?
  • There is no real certainty about when IR35 applies, and it can cost business and individuals a lot of money, so we’ve created this guide to help protect yourself

Timeline of events

2016
IR35 announcement

Off payroll IR35 changes will be rolled out to the public sector primarily. The new legislation will shift liability to the hiring company when determining a contractor’s IR35 status.

2017
IR35 public sector roll out

Public sector hiring companies are responsible for determining IR35 status for workers. The controversial online Check Employment Status for Tax (CEST) tool is used by companies to determine IR35 status, but assumes Mutuality of Obligation applies to all users of the tool - a viewpoint which is not reflected in Tribunal decision making or case law.

2020
IR35 private sector roll out

Medium to large hiring companies or agencies in the private sector will be responsible for determining IR35 status for workers.

How is IR35 status determined?

The end client determines IR35 status and designs the determination dispute process, with no legislative guidance. That status determination is provided in writing to the worker and agency. The end client has 45 days to respond in writing if a contractor disagrees with their conclusion, and there is no right to appeal.

IR35 is determined through a combination of:
Personal service or substitution
Mutuality of Obligation (MOO)
Control

Managing risk / Insulation

If HMRC decide to question your IR35 status, they will ‘look beyond’ the contract by examining working practices. Well written contracts insulate you from IR35 risk.

Highlight how a contractor assignment differs from the work of an employee

  • Contracts should make it clear that weekly minimum hours, pension arrangements or other benefits & subsidised services do not apply to the contractor
  • It should be clear that the employer does not have a duty to provide work for the contractor, and the contractor does not have an obligation to do that work
  • The contract should state that the employer can not stipulate where or how work is to be carried out by the contractor, but if they need to it should be for valid technical or security reasons

What are the limits of insulation?

  • HMRC can set contract content aside
  • Changing practices can impact contract terms
  • Legal judgements pick away at old freedoms
  •  If the law changes you must change with it

Supervision, Direction & Control

Contractors need to limit the degree of supervision, direction and control their client has over what, how, when and where they complete their contract and day to day work.

Don't:

  • No line managers
  • Org charts should not list contractors
  • Contractors shouldn’t follow client instructions and direction in the same way an employee would
  • Clients shouldn’t control how, when and where work is done (though if the work can only be carried out at the client’s premises and in specific working hours this may not be relevant)

Do:

  • Updates & reports should still be provided to hiring managers / project managers
  • Business processes and standards should still be adhered to

Mutuality of Obligation

Disguised employment is a determining factor for IR35. Employment arises when there is an obligation for one party (employer) to offer work and an obligation for the other party (employee) to accept it. Contracts should clearly set out the work to be done and the outcome. Work outside the scope of the engagement should not be accepted, and if it is, the scope should be updated.

Don’t:

  • Don’t include provisions to extend the contract
  • Restrictive covenants should not apply
  • Avoid contract terms where there is an obligation for the contractor to accept work & the client to offer it

Do:

  • Contractors should have the right to work project to project without any obligation to take on the next project or carry on working after the last one is complete

Contract Terms

The best way to insulate an assignment from being outside IR35, is to use a contract that explictly puts the contractor outside of IR35. Use a robust contract, designed to insulate from IR35 application, and make sure working practises are consistent with the contract. Remember, contracts pass risk from one party to another, so don’t accept risk where you don’t have to.

Don’t:

  • Exclusivity clauses should be avoided
  • Employment should not set out regular or guaranteed weekly or monthly payments, including retainers
  • Employment type benefits should not be included

Do:

  • Be explicit about a lack of exclusivity
  • Confirm the intentions of the parties in clear terms, and identify the services of the supplier and the client
  • Confirm payment when the project is completed
  • Detail the work completed, the hours, and the rate if periodic invoices are required
  • Specify use of the contractor's own equipment unless there are technical and security reasons not to
  • Include liability and indemnity provisions
  • Identify termination provisions
  • Manage Intellectual Property with suitable demarcation
  • Ensure your contract references any insurance required, such as professional indemnity insurance for contractors
  • Use GDPR controller and processor distinctions to embed the difference

Substitution

The contractor should propose to the client that every 3 to 6 months they will bring in a substitute resource for a day of knowledge transfer and orientation.

Right of dismissal

The right of dismissal is the right of employers to terminate employment with statutory notice. As contractors or freelancers are normally brought in to provide a service with an end date or state in mind, such as the end of a project, it is best if to ensure there is no mutual contract termination period in the contract, sometimes called right of termination. Contract should only be terminated if one of the parties is in breach of the contract.

Being in business as a contractor

Contractors should show evidence of their own financial risk, and being in business for themselves rather than their clients. Contractors should aim to show as many of the following proofs of business on their own account as possible, as showing just one or two many not be enough for HMRC:

Company names

Contractors should never name their company after themselves, instead they should use a business name that reflects the work being done e.g. ABC Engineering and suggests that it is not necessarily a one person company.

Multiple clients

If possible, contractors should try to split their time fairly between two or more main clients, this makes it harder for HMRC to claim that the contractor is an employee of any of them.

Marketing materials

Contractors should be able to demonstrate their own marketing materials to engage new clients e.g. a website, listing on a relevant services website, or business cards. Branding should be never look similar to client branding.

Company insurance

Having their own company insurance like professional indemnity insurance, is a good way for contractors to demonstrate that they are not an employee.

Office space

Having an office, even one in their own home, software licences and professional memberships in the contractor company name implies that the work carried out extends beyond the current client.

Professional development

Paying for their own training is another way for contractors to demonstrate that they are in business on their own account.

Being part of the organisation

Contractors should avoid being seen as “part and parcel” of the client organisation.

You need to show evidence of:

Do:

  • Show evidence of your own financial risk
  • Use your own equipment
  • Avoid having access to the carpark
  • Avoid having access to the staff canteen
  • Consider avoiding Christmas or work parties
  • Avoid organisation charts
  • Avoid having your name or photo listed on the client’s website

Don't:

  • Don’t attend training, team meetings, team building
  • Don’t become the health and safety officer

Email addresses

Contractors should avoid having a client email address, but if the client insists on giving an email address, our advice is that the email address should clearly identify the contractor as an external resource

e.g. [email protected]

Use of equipment

Contractors should use their own equipment wherever possible, but if they need to use client equipment it should be for valid technical or security reasons. At the very least, contractors should ensure that they use their own equipment when working remotely or from home.

Holidays

External consultants should not be requesting annual leave which is what employees do, instead they should be make the client aware of the days that they are unavailable and give them as much notice as possible. External workers should not be using the client company’s holiday request forms.

Notice periods

Setting notice periods to 0 is considered IR35 compliant, but this is not very practical for clients. Our suggestion is that clients should be able to remove the external consultant with a minimal notice period (from 0 to 14 days). If the contractor hands in their notice, we suggest a more practical notice period of 30 days or more for the client, especially if the client regards their services as critical.

Hubbado suggested notice periods:

  • Client gives: 0 to 14 days notice
  • Contractor gives: 30 days or more notice (especially if their service is important to the client)

Financial Risk

Financial risk is important, but substitution and control are stronger determining factors for HMRC when determining a contractor’s IR35 status. It’s important for a contractor to demonstrate that they are taking a financial risk, as the self-employed are likely to have a higher level of financial risk than an employee would.

Contractors should be able to show that they are investing in their own business for things such as training, tools, equipment and marketing. Where work is deemed faulty or substandard by the client, the contractor is usually expected to correct that work at their own expense and in their own time which also shows that the contractor is exposed to a financial risk.

Company size

Medium and large businesses will be affected by IR35 legislation, but “small organisations will be exempt”. A small company meets two or more of the following criteria:

  • a turnover of not more than £10.2million
  • a balance sheet total of not more than 5.1million
  • no more than 50 employees

Watch the experts from our last IR35 event

Helpful tools & websites

IPSE

Association of Independent Professionals and the Self-Employed
Visit the IPSE IR35 hub

Contractor Calculator

An expert guide to contracting and freelancing, with specific focus on how to beat IR35
Visit the Contractor Calculator IR35 guide

GOV.UK

Find out about the off-payroll working rules (IR35) if you or your worker provides services to a private sector client.
Private sector off-payroll working for intermediaries

Calculate the deemed employment payment for private sector engagements where the off-payroll IR35 working rules apply.
How to calculate the deemed employment payment