It’s crucial for every contractor to fully understand their IR35 status
An alarming number of contractors still aren’t aware of IR35, and those that are may find the legislation too intimidating and bury their heads. IR35 – or the ‘off-payroll rules’ have been active in the public sector since April 2017 and the private sector since April 2021. Larger businesses are already taking precautions with new contractors, with HSBC in September 2019 going as far as to cull contractor relationships altogether, so it’s incredibly important for the self-employed to understand their position.
So how do you know if you’re inside or outside IR35?
In its simplest form, IR35 is anti-avoidance tax legislation. It was introduced by the government to combat and prevent income tax and National Insurance Contributions (NICs) avoidance schemes.
At the time of introduction, there were cases of employees finishing work on Friday and coming back to the same job on Monday as a limited company contractor. This meant that, despite having the same daily tasks and responsibilities, they saved a substantial amount on tax and increased their take-home pay. These workers are dubbed ‘disguised employees’ by HMRC, and it’s this type of tax avoidance that IR35 is designed to tackle.
However, due to the heavy-handed approach taken by HMRC (and its inaccurate Check Employment Status Test – or CEST – tool), many genuine contractors are being stung by the recent legislation reform.
There are many ways to check your IR35 status, but there are three central tests that are universally recognised as off-payroll metre sticks – Control, Substitution and Mutuality of Obligation (MOO). Whilst a tax tribunal would take into account every aspect of your client-contractor relationship, the below are usually pretty telling as to whether you should take further action to prepare for IR35 in the private sector or not.
How much control do you have over your working day? If you have the below in your contract, you could be considered inside IR35:
All the above usually appears in a contract of employment (as opposed to a contract of services, which is what a genuine contractor should have) and can cause you to fail an IR35 investigation. Freelancers and contractors have control over when and how they work.
Can you supply a substitute? If you aren’t well enough to attend a job, could you send someone in your stead to complete the work? If so, then you most likely fall outside IR35.
However, there should be a right of substitution clause in your contract specifying your right to do so as a contractor – if the client has specified that you can’t supply a substitute under any circumstance, then you could be in trouble. Contractors are free to send someone else in their stead, provided the work is completed to an equal standard.
Mutuality of Obligation (MOO)
Can you choose the jobs you work? Does one main client dictate whether you can accept other clients while working with them? If your contract specifies exclusivity or states any number of obligated hours of work a week at a set rate, then you could fail IR35.
Contractors can take whichever projects they choose from whatever client they wish to work with. They should also be free to turn down work from any given client.
HMRC’s CEST tool currently omits MOO, which is a weighty consideration in whether an individual can be classed as a contractor or not. To compensate, make sure the rest of your contract is watertight against Control and Substitution checks as well.
If you fail an IR35 status test and are judged to be inside IR35, you can expect to pay around 25% more in tax every year, which would amount to a huge chunk of money absent every month. You also still wouldn’t benefit from employment rights or have a contract of employment with your client, so you could face critical financial issues with no real benefits or protections to speak of. It’s important to take the necessary precautions to avoid this situation.
Of course, if you are a genuine professional contractor, freelancer or consultant who is in business on your own account, you shouldn’t have anything to worry about. Read up on how the legislation works and apply best practice. It would also be worth having a defence prepared in case you’re investigated by HRMC; whilst you may know that you’re legitimate, IR35 determinations are notoriously subjective.