IR35 came into force in April 2000 and affects all Contracts that the self-employed work under that do not meet the HMRC’s definition of self-employment. It is legislation that effectively allows HMRC to treat some contractors as employees, and tax them accordingly, when they judge that they are employees in all but name.

Three criteria must be fulfilled for IR35 to apply (i.e. this is what you should avoid to ensure you are not caught by IR35):

- The freelancer must personally perform the relevant work.

- An intermediary company must be used, rather than the freelancer contracting directly with the client.

- The terms of the arrangement must be such that the freelancer would have been treated as an Employee of the client for NIC purposes, were they to have been contracted directly.

The implications of IR35 for self employed individuals (and the reasons IR35 is sought to be avoided) are:

- If the contract would otherwise be treated as one of employment under the current Employment Status rules, any fees paid by the client to the freelancer will be treated as employment income for Schedule E Income Tax and NIC purposes, following deductions for expenses. Income will be in the form of a ‘deemed payment’.

- This results in a reduction in take-home pay for many freelancers and may mean you pay more tax than a permanent employee.

- Administration expenses claims on the part of the contractor are limited to 5% of gross fees (which includes premises costs, admin support, accountancy advice, costs of seeking contracts, insurance, training costs, computer equipment etc). However, certain expenses for pension payments, business travel, subsistence (meals and accommodation when away from home), Professional Indemnity cover and benefits in kind (e.g. private medical insurance) can be claimed in addition to the 5% allowance.

- Furthermore, offsetting the costs of sickness, holiday pay, training and so on are not allowable under IR35.

IR35 is very unpopular with Contractors and a large point of contention is that if the Contractor were truly an Employee, they would be entitled to normal Employee benefits. Under IR35, however, the Contractor bears the tax burden but is not entitled to the full rights and benefits of employment.

So, the legal structure under which you operate as a Contractor will partly depend on your IR35 position.