When you start to delve into becoming a contractor, you will soon come across the phrases “IR35”, “Inside IR35” and “Outside IR35”, but what does Outside IR35 mean?
What does Outside IR35 mean?
“Outside IR35” is a classification in the UK that signifies a contractor’s work arrangement does not fall under the IR35 rules, a legislation intended to combat tax avoidance. Being outside IR35 means the contractor is considered to be operating as a genuine business and rather than an employee of the end client.
If the contractor is outside IR35 and not classed as an employee, they are not subject to the same tax and National Insurance contributions as an ’employee’. This status is beneficial for contractors, allowing them to draw income through a combination of salary and dividends, often resulting in more take-home pay due to tax efficiencies. It also reflects a degree of autonomy and control over the work, suggesting that the contractor is in business on their own account.
Who Decides the IR35 Status?
The responsibility for determining IR35 status has evolved over time. Before April 2021, in the private sector, it was largely up to the contractor themselves to determine their IR35 status. However, changes have shifted the responsibility for determining the status of a contract to the client in the public sector and medium to large-sized private sector companies. This means that these entities must carefully assess each contract based on various factors like control, substitution, and mutuality of obligation. The determination is complex, often necessitating professional advice to ensure accuracy and compliance.
This has led to a decrease in Outside IR35 contracts in recent years.
What are the factors in determining responsibility for determining the status of a contract?
The responsibility for determining the status of a contract under IR35 depends on several factors, the first one is the size of the end client:
- Size of the Client’s Organization:
- Since April 2021, Responsibility lies with the client if they are a public sector company, or a private sector company with more than 50 employees. Small companies are exempt, and the responsibility remains with the contractor and their agent.
Determining the IR35 status of a contract involves assessing whether the contractor is operating as a disguised employee for tax purposes or as an independent entity. Here’s how it’s generally determined:
- Control: This assesses how much control the client has over what, how, when, and where the worker completes the work. Less control by the client is indicative of a contractor being outside IR35.
- Substitution: If the contractor can send someone else to do the work in their place, this suggests they are operating a business on their own account and thus outside IR35. The right of substitution must be genuine and not just a clause in the contract that is never used in practice.
- Mutuality of Obligation (MOO): This looks at whether the client is obliged to offer work and whether the worker is obliged to accept it. A lack of mutuality supports being outside IR35, indicating the contractor is not treated as an employee who expects and is expected to have ongoing work.
- Financial Risk: Contractors who bear the financial risk (e.g., rectifying errors at their own cost, incurring expenses) are more likely to be outside IR35. This factor looks at how much the contractor is at financial risk in the same way a business would be.
- Part and Parcel of the Organisation: If a contractor becomes so integrated into the client’s business that they are indistinguishable from employees, this might indicate an inside IR35 status. This could involve having a company email, being listed in the organizational chart, or having management responsibilities over the client’s employees.
- Provision of Equipment: Typically, if contractors use their own equipment for the job, this can indicate they are in business on their own account and therefore outside IR35.
- Length and Regularity of Engagement: Long-term and regular engagements might look more like employment, although this on its own is not a decisive factor. It’s more about how the work is conducted over time.
- ‘In Business on Your Own Account’: This is a more general test looking at whether the contractor is truly operating as an independent business. This might include having a business identity, marketing their services to others, having multiple clients, and the ability to profit from sound management.
- Written Contract: While the actual working practices are most important, the terms of the contract can also be indicative of the IR35 status. It’s essential that the contract reflects the true nature of the working relationship and that the working practices align with the contract.
- HMRC’s CEST Tool: HMRC provides the Check Employment Status for Tax (CEST) tool to help determine IR35 status. While not mandatory, it’s commonly used and gives an indication based on responses to questions about the working arrangement.
Because determining IR35 status can be complex and nuanced, many businesses and contractors seek professional advice to assess their contracts and working arrangements. A wrong determination can lead to significant tax liabilities and penalties, so careful consideration of all these factors is crucial.
What Does Inside IR35 Mean?
Being “Inside IR35” implies that for tax purposes, the contractor is considered an employee of the client, despite working through an intermediary like an Umbrella Payroll company. This classification substantially affects how contractors are taxed, as it requires income tax and National Insurance contributions to be deducted at source, akin to employment taxation.
This status does not typically confer employment rights and can significantly reduce the contractor’s net income due to the higher tax burden (particularly Employers NI). Determining whether a contract is inside IR35 depends on a range of factors related to actual working practices and contract terms.
If I am Outside IR35, Do I Need My Own Limited Company?
While not a legal requirement, operating through a limited company (Personal Service Company) is a common and tax-efficient way for contractors outside IR35. It allows for a combination of salary and dividends, offering tax benefits and enhancing professional credibility. It also allows for Contractors to retain profits and split their payments across multiple tax years, unlike Inside IR35 where you are taxed every week or month.
Additionally, a limited company provides limited liability protection. Although a limited company can often be indicative of a contractor’s independent status, being outside IR35 depends on the entire working arrangement and not just the business structure.
Is It Still Possible to Be Outside IR35?
Yes, it is still possible to be classified as Outside IR35 under current legislation, provided that the working arrangement and contracts reflect genuine self-employment. Staying outside IR35 involves demonstrating autonomy in your work, the right of substitution, absence of mutuality of obligation, taking financial risk, and maintaining a degree of separation from the client’s organization. Each case is unique and should be assessed on its own merits, often with professional advice to navigate the complex IR35 landscape effectively and ensure compliance with the legislation.