The best way to ensure your contracts (and assignments) are outside of IR35 is to ensure they accurately reflect the working practices you follow with your clients. HMRC will ‘look beyond’ your actual contract and examine the working practices you follow on each assignment if they decide to query your IR35 status.
Long-term contractors and freelancers who work through a limited company will need to ensure their contracts accurately reflect the working practices followed in their assignments. Contracts will need to be checked for each assignment on renewal and must provide clear evidence to support your status as a self-employed professional. We have an article “Getting your contracting business ready for IR35" that all contractors should read.
HMRC investigations are not confined to the detail contained in an individual contract. HMRC will ‘look beyond’ the contract to examine the working practices you follow with your clients. If HMRC decides the relationship is of an employment nature, they will seek to recover all income tax and National Insurance Contributions due over the period of the assignment involved.
What's the meaning of IR35?
Before we get going, you might be wondering what the meaning of IR35 is in the first place.
IR35 is not a new tax: in fact, the off-payroll working rules, also known as Intermediaries Legislation, was introduced in 2000. The original press release announcing the rules was entitled Inland Revenue budget press release number 35 – hence the rules became known by the name IR35. The rules are intended to ensure that contractors working through an ‘intermediary’ – usually a personal service company – pay broadly the same income tax and National Insurance Contributions (NIC) as an equivalent employee.
HMRC believes that many private sector contractors, potentially up to 90%, are in fact ‘disguised employees’ and are incorrectly describing their employment status as ‘self-employed’. There can be significant differences in the taxes paid between someone who is self-employed and employee.
HMRC has said that it wants to ensure a level playing field, so that you cannot have two individuals working side-by-side doing a very similar job but being taxed differently, one as an employee and one as a self-employed contractor. HMRC have also said they believe this could affect up to 170,000 individuals working through their own limited company.
What determines your IR35 status, and what does it mean to be inside IR35?
It's also worth clarifying exactly what it means to be inside IR35.
Essentially, being inside IR35 means that the work or service of you provide is, in HMRC's eyes, similar to a service of employment, rather than a service of self-employment.
Being inside IR35 means HMRC will consider you an employee for tax purposes, which will likely end up seeing you pay more in tax than you would if you were a contractor.
The three main principles to decide IR35 status
Determining whether IR35 applies to your assignment is a complex matter. There are three key principles that will determine your IR35 status:
- Supervision, Direction and Control: What degree of supervision, direction and control does your end-client have over what, how, when and where you complete your contract and day to day work?
- Substitution: Are you required to carry out the work yourself, or can you send someone in your place?
- Mutuality of obligation: Is your client obliged to offer you work, and are you obliged to accept it?
These three principles remain the same regardless of whether you work in the private or public sector. You’ll need to demonstrate that they don’t apply to your contract and working practices to avoid being affected by IR35. If your contract with an end client is a contract for services, rather than a contract of service, it’ll usually fall outside the scope of IR35. For example, if you can send another person (‘substitute’) to perform the services agreed in your contract, there’s no obligation of personal service and IR35 shouldn’t apply.
Let’s look at these three key principles in more detail.
Supervision, Direction, and Control (of the worker)
Supervision, Direction and Control are tests of ‘employment’ that could put an assignment inside IR35.
‘Supervision’ means the extent to which your client oversees your work and how you perform it to a standard they have specified.
‘Direction’ means your client directing how you complete your assignment, by providing instructions, guidance and advice as to how the work is to be done. Someone providing direction will often coordinate how the work is done as it progresses.
‘Control’ is where you have someone dictating the work you do and how you go about it. This also includes the power to move you from task to task as priorities change.
These clauses should never appear in a contract – to be truly self-employed contractors and freelancers should have control over when and how they work, not the client. Having a project basis to the work performed is an important indicator of IR35 status.
As a contractor, it’s likely that you’ll work to a comprehensive job specification. This specification would outline:
- The services you’ll be providing
- Where those services are provided
- The hours in each day over which the services are provided.
A contract may go further, though, and say that you must submit to management guidance, appraisal or monitoring. If you find yourself in this position, HMRC will probably conclude you are under the control of your client – this will make you, in their eyes, an employee and not a contractor. For more information on the Supervision, Direction or Control (SDC) test and how to use it to identify your IR35 status, you can read our SDC article.
Another test of ‘employment’ is whether your business can provide a substitute to do the work. You should be able to send a substitute to complete the work on your behalf or reassign the work. The right to send a substitute, however, must be absolute, and not so restricted that you basically have to perform the work yourself. If you genuinely can provide a ‘substitute’ and on occasion actually do, then the contract is likely to be outside the scope of IR35.
If the client is only interested in your own suitability and skills and no substitute can be offered or accepted, then any substitution clause will likely fail under HMRC scrutiny. If you have to personally provide the services agreed with your client, this is usually an indicator that you’re an employee and aren’t self-employed.
Mutuality of obligation
To qualify as a contractor, there must not be a ‘mutuality of obligation’. There are two obligations to consider:
- An obligation for one party to offer work
- If work is offered, an obligation for the other party to accept it.
Put simply, a contractor must work from project-to-project, with no obligation to carry on working for the client after the work is complete. A contractor also has the right to terminate a contract part-way through. An employee, on the other hand, can only work for one company and has an obligation to carry on working when their tasks are complete.
You should also check whether the contract allows you to take on projects from other clients simultaneously, or whether the client can veto other assignments.
If the contract specifies exclusivity, and states that you must work a certain number of hours per week at a certain rate on an ongoing basis and requires you to take whatever work the client throws at you, then this would suggest the contract should be inside IR35.
An IR35-proof contract must state the client has no obligation to offer you more work and you have no obligation to take it (this is what is meant by Mutuality of Obligation). Provisions to extend the contract should be avoided.
Other factors that affect the IR35 status of a contract
Along with the three key areas highlighted above, you need to be aware of the following:
- How you are paid: A contractor will usually receive payment when work is completed, or when project milestones are completed while an employee will usually be paid at regular intervals. If the client requires a weekly invoice, then it should detail work completed during that period as well as hours worked and the rate.
- Alternative work: If you’re contractually obliged to have only one client at a time, you’re probably an employee, not a contractor.
- Equipment: Unless there’s a sound reason (such as for safety, security or practicality), you should be using your own equipment, rather than equipment supplied by your client.
- Premises: The contract should specify where the work will be performed
- Corporate involvement: You could be affected by IR35 if you have any involvement at all with your client’s corporate structure. This applies to even the smallest involvement, such as whether you have a security pass to your client’s building that does not clearly identify you as a contractor, or whether you appear on company organisation charts.
- Financial risks: Regular, guaranteed weekly or monthly work specified in a contract looks more like an employee ‘contract of services’ rather than professional fees paid to a person who is self-employed. Any errors made by the contractor during the contract must be rectified in the contractor’s own time, and the contract should say this. A requirement to maintain professional indemnity insurance is another indicator that you are self-employed rather than an employee.
- Employee Type Benefits: This includes holiday, sick pay, pension – the contract should state these do not apply. Note that the Agency Workers Regulations (AWR) – which would affect Contractors using Umbrella Companies – mean that Agency Workers are afforded the same benefits as permanent employees – the relationship between AWR and IR35 has yet to be explored.
- Part and parcel: If a contractor becomes so integrated into the client’s organisation that they, for example, appear in organisation charts, or have staff reporting to them, then they are behaving exactly like an employee and the contract could fail IR35. The freelancer or contractor should distance themselves from the client’s corporate structure and only take on responsibilities not specified as part of the project when this is the industry norm, such as, for example, safety responsibilities.
- Intentions of the parties: The contract should always clarify the intentions of the Contractor and client (or agency) to be one of supplier and customer and not employee and employer. The nature of the work should be described accurately. If the intentions of the parties, as expressed in the contract, bear no resemblance to the real intentions of the parties, the written intentions will likely be ignored by HMRC.
- Termination: The contract should state that it will be terminated at the end of the project or if there is a breach of contract.
- Blacklists: Check to see whether your client has had any IR35 problems in the past.
Other things you should take into account are being able to demonstrate that you are “in business on your own account” – you may not have stock, premises, or staff but you will probably have an office (even at home), a website, be VAT registered, have business stationery, advertising, invoices, insurance and have other clients and an accountant.
You should always seek specialist advice on your IR35 status, just to be safe. The good news is that Crunch can provide this service for our clients, so get in touch and let us know if you need any help.
What is IR35 video
Need more IR35 advice?
Our “What is IR35?” hub is the place to head for all things IR35 – we have an independent IR35 Calculator tool to help you see if you’re at risk from IR35, a jargon-free IR35 business guide as well as articles explaining everything you need to know about IR35. For Crunch clients, we also have an IR35 service for those looking for our expert guidance.
Another excellent resource for IR35 guidance ins the Gov.uk website – in particular the Employment status guidance for employed or self-employed
Please note that the advice given on this website and by our Advisors is guidance only and cannot be taken as an authoritative or current interpretation of the law. It can also not be seen as specific advice for individual cases. Please also note that there are differences in legislation in Northern Ireland.