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How does IR35 work?

by Sellick Partnership | 7 July 2022

IR35 is an important piece of intermediaries legislation that governs how tax is paid when working with contractors. If your business has appointed contractors or freelancers working through an intermediary, you need to know how IR35 works.

As a business, ensuring that your recruitment activities are conducted in full compliance with all relevant tax legislation should always be seen as a top priority. This means keeping abreast of the latest developments in tax law, and making sure that your organisation has updated its policies accordingly.

IR35 is a good example of a recently updated piece of tax legislation, which was first introduced in 2000, that has had a significant impact on off-payroll working rules and the way that professionals work through intermediaries. If your business regularly works with contractors or intermediaries, it is essential that you have a good understanding of how IR35 works.

Here, we will examine the basics of how IR35 works, how IR35 status is determined, and how to factor these responsibilities into your recruitment activities.

What is IR35? What does IR35 stand for?

IR35 is the commonly used name used to describe the revamped system of off-payroll working rules for businesses, contractors and their intermediaries. The overall aim of this piece of tax legislation is to combat tax avoidance. It prevents companies from engaging contractors on a self-employed basis to ‘disguise’ their true employment status, and thereby avoiding paying the right amount of income tax.

In the past, it was possible for individuals to pay a lower rate of income tax by supplying their services to clients through an intermediary or their own limited company, rather than being on the payroll directly. Businesses would also take advantage of this ambiguity by avoiding having to pay National Insurance Contributions (NICs) for these ‘disguised employees’ or provide benefits such as paid holidays, pensions or sick pay.

IR35 closes this loophole by making it a requirement for off-payroll contractors to pay broadly the same Income Tax and National Insurance contributions as employees, if it can be shown that they would have been classified as employees if they were providing their services directly to the client.

The name ‘IR35’ is not the official name for this piece of legislation - instead, it refers to the name of Inland Revenue (IR, now renamed HM Revenue & Customs) and the number of the press release used to announce the original version of the law back in 1999.

How is IR35 status determined?

Under the IR35 rules, contractors and self-employed workers who are supplying services to a client will be classified as being either inside IR35 or outside IR35. If they are inside IR35, it is deemed that they operate equivalently to employees and should therefore be taxed accordingly; if they are outside IR35, they are seen as being legitimately independent professionals who can pay tax at a lower rate.

A number of factors may determine that a contract should be seen as being inside IR35, including:

  • The worker is required to personally complete the work that they have been contracted to do.

  • The worker receives employment benefits such as paid leave or sick pay.

  • The worker is paid on an hourly or timed basis.

  • The business supervises the worker's activities closely, supplies them with equipment or asks them to work at their premises.

  • The worker is employed by a single client on a long-term basis.

  • Rejected work is corrected at the company's expense.

Meanwhile, the following factors may indicate that a contract can be classed as falling outside IR35:

  • The worker's company has its own distinct branding and premises, and pays its own business insurance.

  • The worker is employed by their own limited company and does not receive paid holidays, sickness leave or other employee benefits from the client.

  • The worker has the right to delegate or substitute work to another person, and has the flexibility to complete the work according to their own schedule, with their own equipment.

  • The worker is paid on a project basis, or at a fixed rate.

  • The worker is contracted by more than one client at a time, or delivers projects for a variety of clients in a short period of time.

  • Rejected work is corrected at the worker's expense.

Examining all of these factors will provide clarity on what the worker's employment status should be under IR35, and ensure that tax deductions can be calculated accordingly.

Who is responsible for determining IR35 status?

One of the key tenets of current IR35 legislation is that organisations which contract workers to provide services through their own intermediary are responsible for determining whether the rules are applicable in their own case. This used to be the responsibility of the individual's limited company, but the duty has now become the client's responsibility in the majority of cases:

  • As of April 2017, all public sector authorities became responsible for deciding whether contracts are inside IR35 or not.

  • As of April 2021, this expanded to all public authorities and medium and large-sized private sector clients.

  • For workers who provide services to small clients outside the public sector, the worker’s intermediary is still responsible for deciding whether the off-payroll rules apply.

As such, any organisations that are utilising self-employed contractors as part of their recruitment strategy need to ensure that they fully understand their responsibilities under IR35, including how the employment status of these contractors might affect their tax liabilities.

Find out more

If you would like to know more about IR35 and how to ensure that your recruitment activities are fully compliant with all relevant tax and national insurance rules, get in touch with Sellick Partnership on 0161 834 1642.