What is IR35?
If you’re a contractor, freelancer or self-employed consultant, that chances are you’ve heard the phrase ‘IR35’ mentioned by your accountant, colleagues or agency. But what exactly is IR35, and how does it affect you?
While business insurance cover such as professional indemnity insurance, public liability insurance and employer’s liability insurance are commonplace for contractors, IR35 is something of a mystery for many.
IR35, named after the ‘Inland Revenue 35’ leaflet which announced the change, was introduced back in 2000 to prevent individuals (who were essentially disguised employees) setting up limited companies to minimise tax and national insurance contributions.
Prior to IR35 being introduced, a self-employed worker could provide services to their client as a one-man-band limited company, taking a large percentage of their earnings as dividends and saving on national insurance contributions and tax deductions, with no way for HMRC to challenge the relationship. A worker could leave employment on Friday, set up as a limited company, and return to the same role on Monday working as a limited company. As this represented lost revenue to the exchequer, the government took steps to enable HMRC to challenge whether someone was in fact continuing their previous employment under a different guide (i.e. as a limited company).
The relationship between the worker and end client
At the core of IR35 legislation is the relationship between the worker (you) and the end client. IR35 seeks to create a hypothetical contract between the worker and the end client that would exist if the worker was engaged directly by the end client (i.e. as an employee) rather than through intermediaries (the limited company and agency).
The (contractual) relationship between the end client and the worker can be classified as falling into two categories:
- A contract for services – a genuine contract for services by a consultant, freelancers or other self-employed person
- A contract of service (disguised employment) – where a hypothetical contract exists between the worker and the end client
If he engagement is considered ‘disguised employment’ by HMRC, the contractor’s limited company would be liable to pay any unpaid tax and national insurance contributions (not the agency or end client).
What’s the difference between a contract for services and a contract of service?
Unfortunately, there is no clear definition of what constitutes a contract for services (self-employment) or a contract of service (employment) exists. However, the following three elements were identified in the famous ‘Ready Mixed Concrete’ Case from 1968 as being consistent with a contract of service (i.e. being an employee rather than self-employed):
- Personal service/substitution: the requirement for the worker to perform the services personally (i.e. they cannot send a substitute)
- Mutuality of obligations: the obligation for the worker to accept work which is offered, and an obligation on the employer to provide work (as well as the employer being able to determine how the employee does the work and prioritise their diary)
- Control: the employer to retain a right of control over the worker
This is by no means an exhaustive list and other factors present must be consistent with a contract of service (employment), including ownership of assets, financial risk and the opportunity to profit.
Let’s look at each of the three areas in turn.
If you are engaged to provide the services personally, and are not able to send a substitute in your place, it would be considered an indicator of a contract of service (employment).
If you can send a substitute to do your work, it cannot be a contract of service.
Mutuality of Obligations
There are two areas to consider under mutuality of obligations.
Firstly, to determine whether there is an obligation for the end client to offer work (as they would do to an employee) and whether there is an obligation for the worker to accept the work (as an employee would be expected to do).
Secondly, to determine whether there is mutuality within the engagement – such as there being an expectation that the engagement must be seen through to the end by the end client.
To fully satisfy the requirement for a lack of mutuality of obligations, it should be clear that a lack of obligations exists not only with regard to ongoing work, but also during the contract period.
This area is a key point in determining whether a contract of service (employment) or a contract for services (self-employment) exists. If the end client does not have the right to exercise control over you, you cannot be an employee. The most important element of control is, however, whether your end client can control ‘how’ you perform the services.
Concerned about your IR35 status?
Contractors, consultants and freelancers operate as limited companies for a multitude of reasons. IR35 is a complex topic, but should HMRC consider your contract to be employment (contract of service) rather than self-employment (a contract for services), your company could be liable to repay an eye-watering sum of tax and national insurance contributions.
Abbey Tax, part of Markel, offer comprehensive contract reviews to contractors, consultants and freelancers on whether your engagement could be considered employment (a contract of service) or self-employment (a contract for services). Along with a definitive opinion on your status, a full written report is provided with suggested contract amendments where appropriate. Having worked in the freelance market since IR35 was introduced in 2000, Abbey Tax experts are ideally positioned to provide guidance on your status.
To take advantage of an IR35 contract review, visit https://www.abbeytax.co.uk/abbey-plus/ir35-services today.