What does Inside IR35 mean?

When you start to delve into becoming a contractor in the UK, you will soon come across the phrases “IR35”, “Inside IR35” and “Outside IR35”, but what does Inside IR35 mean, what are the implications of it and should you consider Inside IR35 contracts?

What does Inside IR35 mean?

“Inside IR35” refers to a classification in the UK’s tax system that affects contractors and freelancers who provide their services through an intermediary, such as a limited company. This classification is part of the IR35 legislation, which is aimed at reducing tax avoidance by workers who are effectively employees in all but name but are operating through an intermediary.

When a contract is deemed to be “inside IR35”, it means:

1. Employment Status for Tax Purposes: The contractor is considered as an employee for tax purposes. Even though they are not an employee in the traditional sense, for the purposes of the contract they are treated as such.
2. Tax and National Insurance Contributions (NICs): The contractor must pay income tax and National Insurance Contributions as if they were an employee. This typically results in a higher tax burden compared to working outside IR35 where a contractor will typically own their own limited company and pay Corporation Tax and Dividends.
3. Responsibility for Determining Status: From April 2021, in the private sector, it is the responsibility of the client (the company receiving the services) to determine whether a contract is inside or outside of IR35. In the public sector, this has been the case since April 2017.
4. Reduced Net Income: As a result of being taxed as an employee and Employers NI also being deducted from the “Day Rate”, contractors working inside IR35 often see a significant reduction in their take-home pay.
5. No Employment Rights: Despite being taxed as employees, contractors inside IR35 do not gain the rights and benefits that come with employment, such as holiday pay or sickness benefits. This is because they are usually employed by an Umbrella Payroll Agency rather than the end client.

It’s important for both contractors and the companies hiring them to accurately determine the IR35 status of a contract, as incorrect classification can lead to financial penalties from HM Revenue and Customs (HMRC).

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 an increase in contractors working Inside 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:

1. 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.
2. 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.
3. 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.
4. 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.
5. 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.
6. 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.
7. 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.
8. ‘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.
9. 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.
10. 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 Outside IR35 Mean?

When a contract or work arrangement is classified as “Outside IR35,” it implies:

1. Independent Contractor Status: The contractor is considered a genuine independent business, not an employee for tax purposes.
2. Control Over Work: The contractor often has more control over how, when, and where the work is completed, reflecting a true business-to-business relationship.
3. Financial Risk: The contractor may bear more financial risk, such as investing in equipment or rectifying work at their own expense.
4. Right to Send a Substitute: There’s typically a genuine right to substitution, meaning the contractor can send someone else to complete the work.
5. No ‘Mutuality of Obligation’: The client is not obliged to offer work, and the contractor is not obliged to accept it, distinguishing the relationship from traditional employment.
6. Tax Efficiency: The contractor can draw income from their business in a more tax-efficient way, such as through a combination of salary and dividends.
7. Limited Company Benefits: The contractor can fully utilize the benefits of operating through a limited company, like claiming business expenses.
8. Client’s Liability: The client is less liable for employment taxes and benefits, as the contractor is not classified as an employee.
9. Contractor’s Responsibility for IR35 Status: In private sector contracts, from April 2021, the client is responsible for determining IR35 status. However, the contractor must also exercise due diligence to ensure compliance.

Being outside IR35 is often preferred by contractors for its tax efficiency and autonomy, but it requires careful adherence to IR35 rules to avoid incorrect classification and potential penalties.

How do I pick an Umbrella Payroll Company?

Choosing an umbrella payroll company when you’re inside IR35 involves several considerations to ensure you comply with tax regulations and receive fair treatment. Here are key steps and factors to consider:

1. You may have a limited choice: The first thing to note is that your end client or your agency may require you to work with specific Umbrella payroll companies. Often there is a shortlist of companies they will allow you to use.
2. Research and Recommendations: You can the start by researching potential umbrella companies. Seek recommendations from colleagues, online forums, or professional networks. Look for companies with a strong reputation in your industry. A lot of the agencies will have Google Reviews or Trust Pilot pages.
3. Compliance with Legislation: Ensure the umbrella company is compliant with all relevant legislation, including IR35 and tax laws. They should be upfront about their compliance measures and able to explain them clearly.
4. Fees and Charges: Understand their fee structure. Some umbrella companies charge a flat rate, while others take a percentage of your earnings. Be wary of companies with hidden fees or those that seem too cheap to be compliant.
5. Insurance Coverage: Check if they provide insurance cover as part of their service, like professional indemnity, public liability, and employer’s liability insurance.
6. Contract and Employment Rights: Ensure they offer a clear contract of employment. This should give you employment rights such as sick pay, holiday pay, and access to a workplace pension.
7. Customer Support: Good customer service is crucial. Assess their responsiveness and availability to support you with any queries or issues.
8. Payment and Tax Handling: Understand how they handle tax deductions and payments. Ensure they’re transparent about how your salary is calculated and when you’ll be paid.
9. Technology and Convenience: Consider how user-friendly their system is. Many umbrella companies offer online portals for timesheet submission and expense claims, which can be a significant convenience.
10. Exit Terms: Understand the terms if you decide to leave the umbrella company. Check for any leaving fees or notice periods.
11. Pension Contributions: Check whether they offer salary sacrifice as an option for pension contributions.
12. Accreditations: Look for any professional accreditations or memberships with industry bodies, which can be a sign of credibility and high standards.
13. Accountancy: A lot of payroll companies are attached to Accountancy firms. If you foresee that you will possibly work Outside IR35 in the future, this might be beneficial for you.

Once you’ve narrowed down your options, you might want to have detailed discussions with your shortlisted companies to address any specific concerns or requirements you have. Remember, the right umbrella company should make your contracting experience smoother and ensure compliance with all relevant tax and employment laws.

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.