IR35 was originally introduced with a 12-month grace period in place, but with HMRC now actively running compliance checks it’s more important than ever to make sure you understand the rules.
What is IR35?
IR35 rules were introduced by HMRC to close a loophole allowing ‘disguised employees’ to slip through the tax-paying net. The initiative is part of broader efforts to tackle the problem of tax avoidance.
These regulations help identify somebody’s employment status for tax purposes so that businesses, freelancers and contractors are all paying the right amount of tax and contributions.
Fun fact: The term ‘IR35’ comes from a combination of Inland Revenue (IR – now HMRC) and Section 35 of the Finance Act 2000, which is responsible for the legislation.
Who qualifies as a disguised employee?
A disguised employee is a contractor who has been hired on a self-employed basis, but the nature of the working arrangement is actually more like permanent employment.
The reason this happens is because employers hire contractors and ask them to work like permanent employees, but pay them as self-employed professionals and keep them ‘off-payroll’.
This means the employer gets to avoid paying National Insurance and other contributions (such as into a workplace pension scheme) and doesn’t have to provide the contractor with any other employee benefits.
The mutual benefit for the contractor is that they can create a limited company and work through that to pay themselves in a more tax efficient way.
Non-compliance can sometimes be the result of a genuine lack of awareness, but the IR35 rules are designed to penalise failure to comply regardless of the reason.
What does it mean to be ‘inside IR35’?
Before a contractor can establish whether or not they are within IR35, it’s important to understand what it actually means to be ‘inside IR35’.
Someone working inside IR35 has basically triggered the rules by working for an employer as if they were self-employed.
What happens if a contract is inside IR35 rules?
A contract falling within IR35 means that the client must add their contractor to their payroll, and pay them through PAYE as if they were any other employee.
Who decides if I’m inside IR35?
You might think that it’s up to you as the contractor to decide, but it’s actually the client’s responsibility to work out your IR35 status unless your client has:
- An annual turnover which is more than £10.2 million
- A balance sheet total more than £5.1 million
- More than 50 employees (on average) during an accounting year
For small private companies, the contractor is still the one responsible for determining their own employment status for tax purposes under IR35.
Key indicators that a contractor should be considered as being inside IR35 include:
- There’s an obligation for the client to provide you with ongoing work and an obligation for you to do it
- You’re a valuable part of the permanent team and you can’t be easily replaced within the role without recruitment efforts
- You aren’t invoicing the client directly to get paid for your services
- The client has control over things like where you work, your working hours and your time off
- You aren’t in charge of your own insurance policies (such as Public Liability and Professional Indemnity)
Whether you’re a contractor or end-hirer, you can use HMRC’s handy online employment status tool to check where somebody stands under IR35. You can also challenge the decision with your client or escalate it to HMRC’s Alternative Dispute Service if needed.
IR35 non-compliance penalties
If HMRC runs an investigation and the end-hirer has not declared applicable contractors inside IR35, they can be liable to pay all the unpaid tax and the outstanding National Insurance Contributions.
Further financial penalties will also be applied on top of this according to the extent of non-compliant activity. The rates of penalty can be broken down into three categories:
- An additional 30% of the unpaid tax: If the end-hirer wasn’t aware that they were in the wrong but HMRC still deems them careless for the error regardless
- An additional 70% of the unpaid tax: If the investigation reveals that the end-hirer was aware of the mistake they were making and chose to deliberately not comply.
- An additional 100% of the unpaid tax: Should the investigation show that the end-hirer actively concealed the employment status of the contractor and therefore evaded paying the necessary tax.
If the investigation is extensive or lengthy, there are also pretty hefty legal costs to consider as part of the non-compliance consequences.
IR35 and the Construction Industry Scheme (CIS)
It’s important to note that IR35 is different from the Construction Industry Scheme (CIS), which only applies to self-employed contractors working within the construction industry.
If you operate in the construction industry, it’s equally important to ensure that you’re up to speed with the rules and responsibilities for contractors and subcontractors under CIS too.
That said, while IR35 and CIS are separate tax schemes, they can sometimes overlap for contractors in the construction industry. Contractors who fall within IR35, for instance, may also be subject to CIS if they are subcontractors working for another contractor in the construction sector.
We promise it’s not as complicated as it sounds, but if you are feeling stuck, speak to your accountant who will be able to steer you in the right direction.
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