Contractors working out income tax, PAYE and NIC using a tax calculator, to be compliant with IR35 working rules

A comprehensive guide to IR35

June 28, 2021

What it is and what it means for your limited company

After a year's delay due to the coronavirus pandemic, the next phase of IR35 legislation was finally pushed through on 6 April 2021, changing the tax landscape for freelancers, contractors and those working through an intermediary. While at first the concept of IR35 may feel like quite a lot to wrap your head around, this guide will give you a stripped-back all-you-need-to-know overview of IR35, what it is and what it means for your limited company.

What is IR35?

IR35 is a piece of legislation that determines if off-payroll workers are 'deemed employee' enough — that is, whether the work they do with a company could warrant employment status — to be subject to taxation, scoring out any loopholes that might otherwise be taken advantage of by contractors and their clients.

If you are classified as "inside" the IR35 parameters — that being, the contract you hold with an employer is similar in nature to that of an employee at the company — you must pay Income Tax and National Insurance, just like any other employee at the company. On the other hand, if you fall outside IR35, you are exempt from paying these employee-based taxes.

Why does IR35 exist?

It all boils down to tax avoidance. In most circumstances, when a contractor is hired by a company they will have more control over their hours, trading the work perks that are typically associated with full-time employment for flexibility and total control over the work they do.

However, contractors will occasionally be a 'disguised employee', meaning that they'll be doing enough work to warrant them as an employee in usual circumstances, but hiding behind an intermediary — usually a personal service company (PSC), such as a limited company  — to avoid paying Income Tax, while their clients simultaneously avoid paying the contractor any employee benefits.

What are the IR35 rules and how do they vary?

As of 6 April 2021, HMRC declared that all public sector clients — including some charities — and medium and large-sized private sector clients are responsible for deciding the worker's employment status with a company. Prior to this change, only companies within the public sector have had to determine their IR35 status, with the previous set of reforms coming into play in April 2017.

The IR35 rules state that if the end-client determines that you are an employee, the fees you are paid will be subject to Income Tax and National Insurance contributions.

For a company to be defined as a medium or large-sized private company, it must meet the criteria outlined in the Companies Act 2006, and is applicable to limited companies, LLPs, unregistered companies and overseas companies. For the entity to fall into this category, it must meet two or more of the following conditions:

  • An annual turnover of £10.2m
  • A balance sheet total of more than £5.1m
  • More than 50 employees

On the flip side, if a private company does not meet the above criteria and is subsequently categorised as a small business, it still remains the worker's responsibility to decide if they fall within IR35.

How do I know if the rules of IR35 apply to me?

If you're not sure whether IR35 rules apply to you as a worker, the first place to look is at your contract. If your contract clarifies that you are being hired for your services only and not for prolonged employment, the rules of IR35 will not apply.

The following criteria is a good rule of thumb to determine if you are being hired on a service-basis only and therefore fall outside of IR35 rules, or if your contract, being closer to a contract of employment, places you within the parameters of IR35.

Supervision, Direction or Control

Determining your status all centres around how much say your client has over when, where and how you complete your work.

If you have complete freedom over your work — both how you choose to complete it and the hours you work to do so — the rules of IR35 do not pertain to you.

However, if your written contract indicates that you are in a position of employment, the rules of IR35 are applicable. Potential indicators of employment include:

  • If you are required to work specific days and hours, with a clearly defined start and finish times
  • You are undertaking additional tasks as and when the client sees fit, on top of the agreed tasks outlined in your contract
  • Your work is closely monitored by the client, with guidance being given on how to complete the assigned tasks

Substitution

If need be, could someone else come in to complete the contract on your behalf, or do you need to do the tasks assigned specifically by yourself?

If you answered yes to the former, odds are the rules of IR35 will not apply to you. However, you'll have to read the fine print here — this needs to be a clearly stated clause in your contract, both to make sure that the work isn't so restrictive it can only be completed by you, as well as allowing you ample time to find other skilled contractors who could substitute for you if need be.

Mutuality of Obligation

Being perhaps the most important of the three tests, mutuality of obligation is often used in tax investigations and tribunals to determine a contractor's employment status. Mutuality of obligation defines the circumstances in which an employer is obliged to give work and the worker is subsequently obliged to accept the work offered.

If your work is wholly dependent on a project by project basis, where the employer is under no obligation to give you any further work once the assigned project has come to an end, you fall outside of the IR35 parameters and do not constitute as an employee.

However, if the employer is obliged to offer you work which in line with your contract you must accept, or if you are not allowed work with other clients simultaneously, your contract indicates employment and the IR35 rules will subsequently apply to you.

Typically, contractors rely on the government's CEST (Check Employment Status for Tax) tool to determine whether or not they fall inside or outside of IR35. This is not always without complication, however — despite numerous updates in recent years, the tool still fails to take into consideration key case law regarding the mutuality of obligation.

We know that navigating the new IR35 rules can be daunting, which is why we're always on hand to help. At Ember, we'll not only automate your accounting and tax for you, but our talented team of accountants are here to offer expert advice as and when you need it. If you're thinking about taking the leap into business, book a demo with us today to find out what we can do to help you thrive.

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Daniel Hogan

Daniel is a Deloitte-trained, fully qualified Chartered Accountant with experience in the finance software space. It was during his tenure managing a finance system in the UK that he grew dissatisfied with the lack of synergy and automation in the space, compelling him to co-found Ember.