Mastering IR35 Rules & Laws

Understanding how IR35 applies in real-life situations can help contractors, clients, and agencies determine the correct tax status.

The IR35 rules are designed to distinguish between genuine businesses and so-called “disguised employees,” who work like employees but pay less tax.

Knowing if a contract is inside or outside IR35 is critical for compliance and financial planning. IR35 explained clearly ensures penalties are avoided.

This article will explore the IR35 meaning and give practical examples that demonstrate how an IR35 assessment works in day-to-day contracting.

What Is IR35?

IR35 is a set of UK tax rules intended to determine whether a contractor is genuinely self-employed or effectively an employee for tax purposes.

It’s also known as the “off-payroll working rules”.

The main aim is to prevent what is called “disguised employment”, where individuals supply services through an intermediary such as a personal service company (PSC) but would otherwise be classed as employees if the intermediary weren’t used.

IR35 considers several factors:

• Level of supervision, direction, and control by the client
• Right of substitution (whether someone else can do the work)
• Mutuality of obligation (the expectation of ongoing work)
• Financial risk and provision of equipment

So, what does inside IR35 mean? Under IR35, if a contract is “inside IR35”, the contractor must pay Income Tax and National Insurance similar to a standard employee.

On the other hand, there’s outside IR35, meaning that the contractor is deemed self-employed and taxed accordingly.

The rules apply to both public and private sector contracts.

The responsibility for determining IR35 status can lie with the end client or the contractor, depending on the size of the client’s business.

Companies considered “small” by UK law may be exempt from some IR35 requirements, with the contractor responsible for determining their own status.

The key IR35 terms are:

When Does IR35 Apply?

IR35 applies when a worker provides services to a client via an intermediary, often their own limited company or personal service company (PSC).

The central question is whether the worker would be classed as an employee if the intermediary didn’t exist.

The HMRC looks at working practices, contracts, and control within the relationship. Key factors include control over the work, substitution rights, and mutuality of obligation.

The indicators that IR35 applies are:

• The client controls what, how, and when tasks are done.
• The contractor cannot send a substitute to do the work.
• There is a continuing obligation for work to be provided and done.

The examples of when IR35 doesn’t apply are:

• The contractor has genuine business risk.
• They can provide a substitute.
• They decide how and when to complete the work.

There’s an IR35 small company exemption where private-sector clients classified as 'small' are not responsible for determining IR35 status. In these cases, the responsibility remains with the contractor.

HMRC provides a tool called Check Employment Status for Tax (CEST) to help determine IR35 status. However, using the tool doesn’t guarantee protection if the information entered is incorrect.

If the engagement is "inside IR35," the worker pays income tax and National Insurance as if they were an employee. If it’s "outside IR35," they’re taxed as a business.

Who Does IR35 Apply To?

IR35 applies to individuals who provide services through an intermediary, such as a limited company or partnership, rather than being employed directly.

The rules are designed to determine whether these workers should be considered employees for tax purposes.

Public sector

Since April 2017, public sector organisations have been responsible for deciding the IR35 status of contractors they engage.

If the rules apply, the fee payer (often the agency or client) must deduct tax and national insurance contributions before paying the contractor.

The key points for the public sector are”

• Applies to government departments, NHS, schools, councils, and similar bodies.
• The client decides IR35 status.
• Responsibility for tax deductions shifts from contractor to the fee payer.

Private sector

Since April 2021, most private sector businesses have also been required to assess the IR35 status of their contractors.

The rules apply to all medium and large companies, but there is an exemption for small businesses.

The important details for the private sector are:

• Applies to companies not classed as “small” under the Companies Act 2006.
• The client decides IR35 status, except for clients qualifying as small businesses.
• Contractors engaged by small companies must determine their own IR35 status.

Individuals affected by IR35 include contractors, freelancers, clients, and recruitment agencies.

The legislation aims to ensure correct employment status for tax and prevent disguised employment.

What Are the Changes in IR35 Rules From 6 April 2021?

The IR35 rules saw significant changes from 6 April 2021, mainly affecting who is responsible for determining a contractor’s employment status in the private sector.

Previously, the individual contractor’s limited company (also known as a Personal Service Company or PSC) was responsible for assessing and dealing with the IR35 status of each contract.

From April 2021, this responsibility moved to the end client, but only if the client is a medium or large business in the private sector.

Responsibility shift

The end client, not the contractor, now determines if IR35 applies for medium and large companies.

Scope

Small companies are exempt from these changes, and contractors continue to self-assess their IR35 status if working for a small company.

Tax liability

If the contract is deemed "inside IR35", the fee-payer (often a recruitment agency or client) must deduct Income Tax and National Insurance from payments to the contractor.

The changes are designed to ensure fairness and compliance in tax payments by aligning contractors’ tax contributions with employees where relevant.

An IR35 determination statement should now be provided to the contractor for each engagement covered by the new rules.

What Do Clients Need to Do?

Clients must determine the IR35 status of each contractor they engage. This responsibility applies to all medium and large companies in the private sector, as well as public sector organisations.

They need to complete an IR35 assessment before work begins.

This assessment should look at the specific working practices and contract terms to decide if the engagement is inside or outside IR35.

Key steps clients should follow when making an assessment are:

• Review each contract and the actual working relationship.
• Use HMRC’s Check Employment Status for Tax (CEST) tool or seek independent advice for assessments.
• Provide a Status Determination Statement (SDS) to the contractor, stating the IR35 decision and reasons.
• Keep records of assessments and communications with contractors.

If a contractor is found to be inside IR35, the client must ensure that tax and National Insurance are deducted at source.

For contractors outside IR35, payment is made without these deductions.

Clients should keep contract terms updated and ensure they accurately reflect working practices. They should also respond to any challenges from contractors about their IR35 status decision.

Small companies in the private sector are exempt from making IR35 determinations, but they should still understand the implications.

What If the Parties Are Overseas?

When either the contractor or the client is based outside the UK, IR35 rules can become complex.

The location of both parties and the place where the work is performed are significant factors.

IR35 usually applies if the client is based in the UK and the work is for the benefit of a UK business. If the client has no UK presence, IR35 may not apply.

However, the contractor’s residency and tax obligations remain important.

Key considerations are:

• UK client, overseas contractor: IR35 can still apply if the services are provided to a UK business.
• Overseas client, UK contractor: The rules may not apply if the client has no UK connection, but other local tax laws could affect the contractor.
• Work performed outside the UK: The specific circumstances, such as where the work is physically carried out, can affect the determination.

HMRC guidance states that off-payroll working rules consider where the client is based and whether it’s a 'relevant' client for IR35.

Contractors should perform a careful IR35 assessment for cross-border work and may need professional advice.

Key Takeaways

IR35 is UK tax legislation designed to differentiate between genuine self-employment and "disguised employment" for tax purposes. 

Contractors must determine whether their contracts are "inside" or "outside" IR35, as it affects their tax and National Insurance contributions. 

Since April 2021, the responsibility for determining IR35 status shifted to medium and large clients in the private sector, although small businesses are exempt.

Accurate assessments and documentation are crucial for compliance and to avoid penalties, especially with international or cross-border contracts.