Understanding IR35 Risks for Contractors and FreelancersBack
IR35 is designed to prevent ‘disguised employee’ arrangements. This situation arises where a person labels him or herself ‘self-employed’ despite fitting the legal description of an employee. These arrangement are designed to shield the individual from paying national insurance and PAYE tax on his or her earnings. Here a person typically operates as a limited company and pays him or herself through company dividends. Company dividends attracts no PAYE. These individuals thus gain a tax advantage over employees who must pay PAYE on their earnings.
IR35 laws were introduced in 2000. IR35 is commonly referred to as ‘intermediaries’ legislation’. IR35 mostly affects those trading as a contractor or freelancer, although many small business owners may also be caught by the legislation. The aim of IR35 is to discover the true employment status of the contractor or freelancer concerned and charge PAYE appropriately.
HMRC applies a series of tests in deciding whether IR35 applies or not to a given relationship. If you become subject to an IR35 investigation, HMRC either rules you are a genuine contractor or that you a disguised employee. In the latter scenario HMRC charges you the tax you should have paid as an employee.
The extend of your liability
Taxation liability arising from an adverse IR35 decision includes:
- Employer’s NI contributions
- Employee’s NI contributions
- PAYE Taxation on income
- A penalty up to 100% of the tax due
Mitigating your risk
An adverse IR35 decision could cost you dearly. At The Financial Management Centre we urge our clients to assess IR35 status before a new assignments is accepted. If the assignment falls under IR35 you may consider turning the work down in favour of work not falling under the remit of IR35.
When taking on new assignments you must make ‘reasonable steps’ when assessing your potential IR35 liability. You must look deeper than the wording provided in a written contract, particularly when the contract has been drafted by a recruitment agency. HMRC looks at the ‘notional contract’ between you and the hiring company. This means HMRC looks at the ‘working arrangements’ under which you work. For instance if you retain some control over how you work, HMRC may conclude you are a contractor. If your activities are wholly managed or supervised by the hiring company, HMRC may conclude the assignment falls within the remit of IR35. Here you become liable to pay PAYE.
Typical evidence proving a lack of IR35 status
Factors going against IR35 status include:
- Non-exclusivity of customer
- Taking on your own insurance
- Providing your own equipment such as tools
- Investing in your own marketing materials e.g. website, stationary and literature
- Ability to replace yourself with an equally qualified substitute
- Taking on your own employees
The above factors strengthen your claim as a self-employed worker.
Obligation to take ‘reasonable steps’ in assessing IR35 status
The rules on IR35 are fairly complex and based on case law of instances brought before a court of law. We thus urge you to seek the services of a qualified IR35 expert. Seeking out such an expert means you are able to demonstrate you took reasonable steps when assessing your IR35 status. These steps serve to mitigate a penalty if HMRC successfully challenges your IP35 status.
HMRC is likely to take a dim view if you claim you based your IR35 assessment merely on your recruitment agency’s advice.
The obligation to review an assignment’s IR35 is a continuous one. If an assignment is extended or materially altered you must take reasonable steps to re-assess the assignment’s IR35 status.
HMRC’s IR35 helpline for contractors – call on 0845 303 35235.
HRMC’s Business entity test.
HMRC’s main IR35 advice page.