A guide to IR35: understanding the off-payroll working rules
IR35 got an important mention on Free-Work last week, with the news that Microsoft appears to be amending its stance on the off-payroll rules, by looking to re-take on limited company IT workers from April 6th 2024.
IR35 confusion for tech freelancers be like this…
But what is IR35? Has IR35 changed since it was introduced in the UK? What does inside IR35, and outside IR35 mean?
And perhaps most importantly for IT freelancers, writes Charlie Hemsworth, senior consultant at status advisory Bauer & Cottrell, what does getting IR35 right, actually look like in 2023?
Here, I will answer these fundamental IR35 questions to working as an IT contractor or technology freelancer, exclusively for Free-Work.
What is IR35? A brief history of the Intermediaries legislation
IR35, which is shorthand for the Intermediaries legislation, is a piece of UK tax legislation that was introduced in the year 2000 through Chapter 8 of the Income Tax (Earnings and Pensions) Act 2003. The purpose of IR35 is determining employment status for tax purposes.
IR35 is relevant to individuals who offer their services or work through an intermediary entity, such as a limited company (sometimes referred to as a ‘personal service company’). It can also affect technologists working through a partnership.
Trading through a limited company in a genuinely self-employed capacity offers certain tax benefits, mainly to do with the tax treatment of dividends, of which you are entitled to payment of as a shareholder. However, prior to the implementation of IR35, taking advantage of these tax benefits by working through a limited company was vulnerable to exploitation.
In essence, the Intermediaries legislation aims to address ‘disguised employment’ by ensuring that individuals who receive payments from a client (an engager) through an intermediary -- and have a working relationship similar to that of an employee -- are taxed by HMRC in a manner consistent with employees.
What is IR35 currently?
IR35 has to be considered for each and every contract you undertake.
Historically, the responsibility for determining IR35 status (whether ‘inside’ IR35 to indicate applicability or ‘outside’ IR35 to indicates non-applicability), and ensuring the proper tax is paid, rested with the contractor/freelancer working via their limited company.
But on April 6th 2017, a significant change occurred, shifting this responsibility for IR35 status decision-making and compliance to public sector clients, for engagements with them.
Then, similarly, on April 6th 2021, the rules extended to include medium and large organisations in the private sector, whereby they too became responsible for IR35 status, including the assessment of whether the legislation applies. These newer rules are covered in Chapter 10 of the Income Tax (Earnings & Pensions) Act 2003.
Status Determination Statement, it’s your IR35 assessment under the OPW rules
So, as it stands today, limited company contractors working at or on behalf of either public sector or medium and large private sector organisations can no longer decide their IR35 status -- instead the engaging party -- the client -- is the party responsible for making the decision and issuing the decisions in what’s called a ‘Status Determination Statement’.
The SDS states whether the contract is ‘inside IR35' or ‘outside IR35' and provides the client’s reasons why. Additionally, the ‘fee-payer’ (the client if the contract is direct, or more typically a recruitment agency) is required to make ‘deemed employment deductions’ -- at source, if the engagement is determined as inside IR35.
These newer (Chapter 10) rules now govern most limited company engagements in the UK.
However, there are still instances where the contractor is responsible under Chapter 8, either for engagements with “small” company clients (as defined by the Companies Act), or wholly overseas clients (not within the UK tax jurisdiction).
Either way under both sets of these IR35 rules, the responsible party is obligated by statute to take “reasonable care” in arriving at their status decisions.
What is the difference between inside IR35 and outside IR35?
The relationship with the client amounts to employment for tax purposes and therefore employee rates of tax are due on the entire income.
This is either deducted at source by the fee-payer for engagements under Chapter 10, or handled in your company tax returns where you are responsible under Chapter 8.
The relationship with the client reflects that of genuine self-employment.
Your payments will be gross, and you are entitled to the tax advantages of working for your own business, notably deciding your own salary and being able to draw profit out as dividends. This status, due to it being a LOT less taxing, is the IR35 status contractors and freelancers invariably want to have!
How is IR35 status decided?
While the changes to the IR35 regulations in 2017/021 have shifted the responsibility for determining IR35 status, the fundamental criteria that decides IR35 status remains the same and it’s rooted in decades of IR35 and employment status case law.
In determining status, it is crucial to assess both the contractual agreement and, more significantly, the actual working practices apparent in the daily interactions between the individual worker and the client.
Here is an overview of some of the main factors that decide IR35 status and must be considered for each and every contract.
Control: Arguably the most determinant factor, ‘Control’ relates to the client's rights and the extent of control they (can) exert over the worker. It looks at control over 'what' tasks are performed and the 'how,' 'when,' and 'where' of their execution.
Personal service / substitution rights: This involves whether there's a requirement for a specific individual to perform the work or if the client would accept anyone with the necessary skills and qualifications.
Mutuality of obligation: Often shortened to just Mutuality or MOO, this relates to whether there is a reciprocal obligation between the client and the worker to offer and accept work, both during and beyond the termination of the contract.
Financial risk: A more secondary factor nowadays but nonetheless important, this focuses on whether the worker assumes financial risk, which includes costs incurred in completing the work, responsibility for defective work and negligence, and the basis of payment.
Other factors which can inform IR35 status, and to therefore consider are:
the presence of employee rights/benefits,
the worker's integration within the client's organisation (known as ‘part and parcel’)
exclusive service arrangements, and;
shared intentions between both parties.
This list is not exhaustive.
And each of these factors contributes to forming an overall picture of IR35 status. And IR35 status, to arrive at an accurate determination, must be assessed in its entirety.
The importance of getting all things IR35/ OPW right
So, a quick summary of both IR35 and the OPW (Off-Payroll Working) rules:
If your client is a public sector or medium/large organisation in the private sector – they are responsible for your IR35 status decision and must issue you with an SDS confirming their decision and the reasons why.
You should ensure you have this decision before you start or sign any contracts. If the decision is inside IR35, the tax/NIC will be deducted at source from whoever pays you.
But you have the right to object the decision – albeit only to the client who has decided -- if you do not agree with the determination. The engager must respond to you within 45 days but be aware, they can simply stand by their original determination.
However, either the client or fee-payer is on the hook if they get the IR35 status wrong! But here’s a top tip – keep a look out for any indemnities in your contract that attempt to pass tax risk on to you. Unfortunately for IT freelancers, we see these clauses all the time!
If your client is a small company or wholly overseas – you are responsible for deciding yourself if you are inside or outside IR35.
You are obligated to take “reasonable care” in compliance with the rules and are liable for underpaid tax/NIC and significant penalties if you get things wrong.
You therefore need a good understanding of where your working practices place you, and should ensure your written contract wholly supports your position.
Finally, if in doubt talk it out (with an expert)…
As you can see, there is a lot to consider with IR35!
And non-compliance with today’s IR35 / off-payroll rules can have significant implications and HMRC liabilities for contractors/freelancers, engagers and agencies -- and potentially any other parties within the contractual chain as well!
If in doubt, it’s always prudent to seek the advice of an IR35 reviewer or status specialist, who can comprehensively review your personal circumstances and contracts, to ensure that you, or the relevant party, has taken reasonable care and that your tax risks are mitigated as far as possible. This serves to provide protection and peace of mind for all parties involved. Good luck!
Tax Consultant at Bauer and Cottrell
Charlie Hemsworth has been a tax consultant at leading IR35 and employment status specialists Bauer and Cottrell since 2015, and has over 20 years of experience in the contractor industry. She currently advises contractors, engagers and agencies in all things IR35 / Off-Payroll, ranging from IR35 reviews and assessments, to representing clients in HMRC enquiries.