Contractors are an important part of both the private and public sectors, contributing more than £300bn to the UK economy every year, and covering a range of roles, from HGV drivers to bricklayers, architects to accountants, and engineers to plumbers, to name just a few.
IR35 was introduced to help minimise the risk of tax avoidance within the contracting sector, so if you carry out work as a contractor, it’s essential to know what these rules mean for you, and what records you must keep.
What is IR35?
IR35 was actually first introduced in the year 2000 to crack down on tax avoidance within the contracting sector, but the rules have changed several times since. The name IR35 comes from Inland Revenue’s Press Release 35 – the very first press release that announced its arrival more than 20 years ago.
In a nutshell, if your work is subject to IR35 rules, you’ll be treated as if you’re an employee of the company you’re contracting for, even though you’re technically self-employed.
What brought IR35 about?
During the 1990s, it became popular for contractors to set themselves up as limited liability companies. It was soon recognised as a much more tax-efficient way of doing things. But with contractors then appearing to the government as not being genuinely self-employed, it deemed this to be a form of tax avoidance that needed to be stopped.
This is where IR35 comes in. It basically prevents someone going from being employed one day to self-employed the next, whilst still working for the same company, doing the same job. By setting yourself up as a consultant in this way, rather than being employed, it used to be possible to save yourself a fair amount of tax and national insurance. It’s this loophole the government tried to close with IR35.
How do I know if IR35 applies to me?
According to HMRC, whether IR35 applies or not depends on the employment status of the person doing the work. It also highlights that the off-payroll rules should be applied if a contractor would be directly employed if there wasn’t an intermediary. Usually this intermediary is the contractor’s limited company.
If you’re a contactor working on several contracts at once, you might find that some of these contracts come under the off-payroll working rules and some don’t. The reason for this is that the rules are applied individually to each contract.
How do I know if I am inside or outside of IR35?
If your work is considered to be inside IR35, you’re technically treated like an employee in terms of PAYE tax. But if you’re self-employed, you’re then outside of IR35 and can pay yourself through your own limited company. This brings certain tax advantages (like the chance to pay yourself dividends alongside your salary, which is often more tax efficient).
HMRC will consider you inside or outside of IR35 based on the following criteria:
Control
Is your client closely managing you or do you have free reign over your work? If you’re truly self-employed you’re likely to have much more control over your working hours, pay, conditions etc.
Substitution
Could you send someone else to do your work if you needed to? Obviously an employee wouldn’t be able to do this, but you might if you’re contracting under your own company.
Employee benefits
Is the company you’re contracting for offering you things like sick pay, holiday pay or parental leave? If so, HMRC will probably see you as working inside IR35 rather than outside.
Mutuality of Obligation (MOO)
Are you obligated to take on more work for the client in future? Are they obligated to take you on again? If so, there’s an element of Mutuality of Obligation which means HMRC is likely to consider you employed rather than self-employed, therefore inside IR35.
Who works out IR35 status?
First of all, you need to know about the off-payroll rules in the public sector versus the private sector.
Off-payroll working rules in the public sector
If you’re a contractor who has taken on work for an organisation in the public sector, it’s their responsibility to determine if IR35 applies or not.
If you do come under IR35 rules, whoever is paying you (whether that be the organisation, an agency or any other third party) should report your earnings to HMRC. This also makes it their responsibility to take off your tax and National Insurance contributions at source.
Off-payroll working rules in the private sector
The rules around off-payroll working in the private sector were updated in April 2021.
Essentially, if you’re a contractor working for a larger business, then they need to work out your IR35 status. Again, whoever pays you should also take off your tax and NICs as a deduction.
However, this rule doesn’t apply if it’s a smaller business you’re working for. In this case, working out your IR35 status is down to you.
So the next obvious question is: How do I know if I’m contracting for a small business or not?
The answer is, they’ll be classed as a small business if they meet two of these criteria, for two consecutive financial years:
- 50 employees or fewer
- Balance sheet total of less than £5.1 million
- Annual turnover of less than £10.2 million
So what records should l keep?
The onus is on you to make sure you can justify your IR35 status and back it up with evidence.
1. Documenting your working relationship
If you think you fall outside of IR35, it’s a good idea to build a good case to support that. Note down the level of control you have over your work, in terms of providing your own equipment and setting your own hours. Did you (or could you) send along another worker in your place at any point? Are there any mutual obligation commitments?
We also recommend keeping records that help prove that you’re working under your own business rather than as an employee. This would be things like:
- Evidence that you’ve got your own insurance policies, such as public liability or professional indemnity insurance
- Evidence of having several clients on your books, rather than just the one
- Having your own website and marketing materials
2. Discussing IR35 with your client or recruitment agency
By working outside IR35 when you should be inside not only could you end up in trouble with HMRC but so could the organisation you’re working for. Your clients or recruiter could then get a hefty fine.
However, if you’re placed inside IR35 when you should be outside, your client is effectively incurring higher costs on a less flexible workforce. Any agency involved will also make less profit.
An open, honest chat with your client or recruiter should help prevent problems later on. Again, make sure you make a note of when you had the chat, when, who was present and what was agreed.
3. Writing everything down
We can’t emphasise this enough. Not only should you note discussions and keep records yourself, but get a Confirmation of Arrangements in place too.
This document will basically outline the reasons why you’re inside or outside IR35, and confirm your IR35 status as discussed with your client or agency. It can really help to show HMRC you’re serious in complying properly.
4. Making your contract IR35-proof
Everything you do is based on your contract between yourself and your client. If you believe you’re outside IR35, it’s well worth including a clause that states the exact work you’re undertaking. It should also lay out the fact that you can choose when and where you work, and whether you can substitute yourself for another worker.
Add a clause in there too around boundaries. For example, the right to work from your own premises if you decide to, and highlighting the fact you don’t take any employee benefits. A non-exclusivity clause is a good idea as well. This outlines your ability to work on other projects without having to get the permission of your client.
The whole point here is you need a watertight contract that accurately reflects your working practices and backs up your IR35 status. Consider getting a trusted accountant or IR35 specialist to look over it for you.
Why is record-keeping important for IR35?
If HMRC suspects any hint of fraud, it can launch an investigation that looks as far as 20 years back. If you’ve been working outside of IR35 but HMRC thinks you should have been inside, it’s likely to have huge financial implications for you.
- For example, a 30% penalty can be applied on unpaid tax if HMRC believes you’ve been careless (again, this is where record-keeping is a lifesaver).
- HMRC can also apply a 70% penalty on unpaid tax if it thinks a contractor calculated their tax wrongly.
- This can rise to a 100% penalty if it’s believed a contractor tried to hide their underpayment on purpose by not calculating their tax accurately.
It’s not worth the stress, cost and hassle of getting caught out, however innocently.
Learn more about Pandle’s timesaving bookkeeping features for contractors, freelancers, and small businesses.
