As freelancing and self-employment become more popular, amending taxation laws to regulate working conditions of freelancers has become increasingly necessary. Some countries have made changes to taxation laws, and the UK is among them. In this guide, we will discuss IR35, the UK’s latest rules regarding taxes for the self-employed, and organisations and clients working with them.
IR35 stands for “Inland Revenue 35”, which was a press release by HMRC (named Inland Revenue at the time) announcing the Intermediaries Legislation in 2000. IR35 is commonly used to refer to a set of rules regarding off-payroll employment. According to IR35, all contractors (self-employed professionals) and intermediaries who provide a service to clients must pay the same amount of Income Tax and National Insurance contributions as “employees”.
The IR35 rules were put in place by the HMRC in order to prevent misclassification of employees and get ahead of tax and National Insurance contribution evasion done by “disguised employees”, or contractors who should have been on-payroll employees. When an employee is misclassified as a contractor, both they and clients are allowed to pay less tax and National Insurance contributions. The government aims to prevent the use of unfair tax advantages by employees and increase national tax revenue with the IR35 rule.
HMRC does not have a clear, set definition of self-employment when it comes to IR35. However, all we need to know is who is liable to the rules. If the working conditions of a contractor resemble those of a full-time employee, they are considered to be “inside IR35”.
Here are some differences between contractors and employees:
When IR35 was first announced by HMRC in 2000, it only addressed disguised employment in the public sector. In April 2017, the rules went through a reform, and by October 2017 there were hints at the private sector being included in the coming years. Which was true, as reforms including the private sector started being implemented in April 2021.
The newest reform to IR35 means that now, private sector companies and clients have a responsibility to assess whether the contractors they are working with off-payroll are subject to the IR35. This responsibility was only on the contractors before. Now, if end-users (companies or clients working with contractors) find their contractors to be “deemed employees”, they have to pay the appropriate taxes along with National Insurance and Social Care contributions. This includes intermediaries like agencies. However, small businesses are exempt from IR35 rules.
The off-payroll working rules of IR35 applies to all contractors that provide services to clients through their own limited company or through an intermediary. The IR35 also applies to clients under the same circumstances. End-users soliciting services from a contractor through an intermediary or the contractor’s own limited company, are also liable to IR35 rules. Intermediaries are also required to assess the contractors providing services to clients through the company on whether they are “deemed employees”.
A contractor’s own limited company can count as an intermediary, but intermediaries can also be partnerships, recruitment agencies, or other agencies that provide services from independent workers.
The IR35 rules are applied on a contract-by-contract basis. Which means that a contractor can be a “deemed employee” under some of their work contracts, while falling “outside IR35” according to their other contracts.
Small businesses are exempt from IR35. The Companies Act of 2006 defines small businesses according to the following criteria:
IR35 rules also don’t apply to individuals that are completely self-employed, some that own and manage their company or those working in the public sector. However, as IR35 rules and compliance are evaluated on a case-by-case basis, it will depend on the particulars of the work and the service agreement.
A contractor inside IR35 is someone who could be classified as an employee if they were to be contracted by the end-user (client) directly. The contractors that are inside IR35, therefore “deemed employees” are now considered employees of the client when it comes to tax regulations. Contractors that are inside IR35 are paid per hour/day, work from the client’s premises and/or use equipment provided by them.
Contractors outside IR35 can be determined by similar, but opposite factors. Contractors outside IR35 use their own equipment to work and conduct work on their own premises or public places, are paid on a fixed rate and on a per-project basis, undertake all costs regarding rejected works or revisions, and can offer a substitute in order for the contracted project to be completed. Contractors outside IR35 are responsible for paying their own taxes and NICs.
The right of substitution is when a contractor has the right to offer a substitute or hire someone else for the completion of the project agreed upon in the contract. Mutuality of obligation is a term used to describe the status and continuation of contracts between individuals and clients. If the agreement between a contractor and an end-user is set up to be continuously renewed, or the end-user can make another contract and the contractor is obliged to accept the new one, this would be considered as inside IR35. Whether a contractor falls inside or outside IR35 can also be determined by evaluating the rights of control in a work contract.
With the new reforms to IR35 rules, now all parties in an off-payroll working relationship have the responsibility to evaluate and use reasonable care when determining the IR35 of a contract. To comply with IR35, end-clients (individuals or companies working with contractors through an intermediary) are now obliged to produce a Status Determination Statement (SDS) for contractors they work with. Intermediaries, as well, have to produce SDSs for every contractor working through their organisation. Penalty fees can be enforced for non-compliance, which can add to the already existing costs.
Changes to tax regulations can put businesses in a tough spot. Depending on the scope and nature of the change, businesses might need to re-evaluate their working systems, contracts and/or tax rates. Here are some of the challenges businesses might find themselves facing after new reforms in IR35 rules:
In order to overcome these challenges, businesses may consider investing in new tools or hiring expert consultants to help them navigate the changes in IR35 regulations.
To remain compliant with IR35 rules, businesses, clients, and intermediaries might need to re-evaluate parts of their businesses, and make sure they classify their employees and contractors properly. Here are some suggestions for businesses/clients on how to stay compliant with IR35 if they are working with contractors:
For contractors in the UK, having a “deemed employee” status is only in regards to taxation regulations. If a contractor is found to be inside IR35, their employment status still stays the same. Also, when it comes to small businesses, contractors have the responsibility of determining their IR35 status by themselves. The reforms to IR35 rules can have a significant impact on a contractor's income, as they may have to pay higher taxes and National Insurance contributions if they are deemed inside IR35.
If you have a business that might be inside IR35, collect and archive records properly and consult with legal professionals to make sure you are legally compliant in your working conditions. Furthermore, it is important to stay up-to-date on the latest changes to IR35 rules and regulations, as they can have a significant impact on your business, and take proactive measures to ensure compliance. Remember, diligence is key in maintaining a successful business.