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.
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.
This article covers:
- What is IR35 and what is the meaning of it?
- Am I an employee or a contractor?
- The three main principles to decide IR35 status
- Supervision, Direction, and Control (of the worker)
- Mutuality of obligation
- Other factors that affect the IR35 status of a contract
- Need more IR35 advice?
What is IR35 and what is the meaning of it?
A very brief history - IR35 was introduced in 2000 to address the problem of people working through personal service companies to avoid paying employment taxes. It was designed to make sure workers and employers pay the right amount of employment taxes, particularly where employed workers and self-employed contractors were undertaking similar work.
Through a limited company, you’re able to split your income and the associated Income Tax and National Insurance Contributions (NICs) based on a low salary and high dividends – thereby paying less tax than an employee.
If IR35 applies to your contract, it means you pay the same Income Tax and National Insurance contributions (NICs) as you would if employed directly rather than contracted to work through your limited company.
The financial impact of IR35 can be significant. You may find your future earnings are reduced and have to pay Income Tax and NICs it calculates as due from prior years.
HMRC can determine if the relationship between you (as the worker) and the end-client would be seen as an employer/employee relationship, if the agency you work for and/or your limited company wasn’t in place. Breaking it down: IR35 determines if you’re an employee of the client or whether your limited company is providing services to that client.
There were a number of changes to the IR35 rules that were scheduled to be rolled out for private sector businesses in April 2020, but the COVID-19 crisis means this has been delayed for another year. Businesses now have an extra year to plan for the changes, now set to be implemented on 6th April 2021. We’ll cover the changes later in this guide.
Before we start, here are some terms you’ll come across over the following pages:
Personal Service Company: a company that sells the work or services of an individual (or group of individuals) that is owned and operated by that individual (or group of individuals).
Intermediary: the entity that sits between the end-client and the worker, such as the agency or limited company.
End-client: the company that is actually engaging the contractor or personal service company to carry out work for them.
Am I an employee or a contractor?
You might imagine this would be a fairly straightforward process. You may think that because you have a limited company and the work isn’t permanent, you’re a contractor. Well, unfortunately, it isn’t that black and white, and there’s a variety of questions you should ask to establish your employment status.
It’s important to remember that IR35 is designed to cover a large number of scenarios. There is no single situation to prove IR35 rules apply or not. What is important is that the contract between your limited company and the agency or end-client, and the actual working practices you follow, clearly show that you should not be regarded as an employee of the end-client you are providing services to.
HMRC is becoming increasingly tough with regards to IR35 enforcement. In the public sector, they introduced changes for public sector assignments in 2017 that put the responsibility on the end-client (or agency) to determine the IR35 status of people providing services via limited companies. This has led to an increase in the number of contracts deemed to be ‘inside IR35’ in the Public Sector and an increase in the amount of employment tax paid to HMRC. As we mentioned above, the government intends to implement similar rules for most of the private sector in April 2021. This means it’s important to be able to show that you’re not a ‘disguised employee’ of your end-client and that you are working legitimately as a contractor through your limited company.
The first thing to consider when approaching IR35 is whether your work is controlled and directed by you, or if you are subject to an employer/employee relationship.
The three main principles to decide IR35 status
Determining whether IR35 applies to your assignment is a complex matter. You should seek specialist advice (Crunch can provide this service). However, 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.
Are you required to carry out the work yourself, or can you send someone else in your place? If you have to provide your services personally, this is usually an indicator that you’re an employee. 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 three obligations to consider:
- An obligation for one party to offer work
- The worker has an obligation to complete a notice period of similar length to that if they were an employee.
- 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.
To qualify as a contractor, make sure these apply to you and that there is no ‘mutuality of obligation’. Regardless of the sector you work in, these three key principles remain the same. If you can clearly show that any one of these principles does not apply, you shouldn’t be affected by IR35. This is because the relationship with your client will be seen as a contract for services, rather than a contract of employment. For example, if a worker can send a substitute in their place, and that decision is not fettered in any way, personal service is not required and IR35 does not apply.
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.
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.
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.