What is IR35?
In summary, IR35 is a tax legislation that aims to prevent tax avoidance by workers who operate through an intermediary in the UK. Referred to as ‘disguised employees’ by HMRC, these individuals appear and act as employees, despite not being on the payroll. Instead, they’re registered as a limited company to pay less tax.
The IR35 rules ensure that independent contractors who work in a manner similar to employees pay the same income tax and National Insurance contributions as employees, regardless of whether they operate through a limited company.
What does ‘IR35’ stand for?
IR35 is not a new tax; in fact, it has been in place since 2000. The rules were originally announced in a press release called Inland Revenue budget press release number 35. Since then, its rules have been referred to as IR35.
Who is affected by IR35?
The following parties may be affected:
- a worker who employs an intermediary to provide their services
- a client who uses an intermediary to get services from an employee
- an agency that provides workers’ services through an intermediary
An intermediary usually refers to the worker’s own personal service company (or PSC in short), but it can also be any of the following:
- a partnership
- a company
- an individual
The client is the organisation or the company who will receive the services of the contractor. They may also be called the hirer, end client, or engager.
Does IR35 concern the public or private sector?
The responsibility lies with the public sector body, as they are deemed best equipped to determine the contractor’s status. Prior to the public sector reform in 2017, the responsibility was on the contractors themselves.
The private sector rules were reformed in 2021, prior to which the responsibility was also on the contractor. Today, companies are responsible for determining the IR35 status of their contractors if they meet certain criteria. If they don’t, the responsibility is shifted to the contractor. We’ll cover these criteria in the section to come.
What about sole traders – are they affected?
In short, sole traders are self-employed and do not need to worry about IR35. The legislation only applies to incorporated businesses, so sole traders are not affected.
However, while IR35 may not apply to sole traders, employment status does. The rules for determining employment status are very similar to those for determining IR35 status.
Who determines IR35 status?
Public authorities contracting workers through an intermediary are responsible for determining whether their contractors are outside IR35 or not.
Private sector companies are responsible if they meet two of the three following criteria:
- £10.2M+ turnover,
- £5.1M+ on their balance sheet, or
- 50+ employees
In other words, by meeting at least two of the criteria, you will be regarded as a medium or a large company. All medium and large end-clients will be responsible for properly classifying their contracts based on certain IR35 indicators.
On the other hand, if you meet none (or only one) of the above criteria, you are considered a small company. In this case, you are exempt from making your own IR35 determinations – instead, the responsibility will be on the contractor.
How to determine IR35 status
As stated, if you qualify as a small company, you don’t need to worry about IR35 – it becomes the contractor’s responsibility. Companies of medium-size and above, however, must determine the status of their contractors. To get a better understanding of how the status is determined, let’s first take a look at the definitions of ‘inside’ and ‘outside’ IR35.
Contractors working ‘inside IR35’ will be required to pay Income Tax and National Insurance Contributions, just like a permanent employee would. However, employee benefits like sick pay will not be provided, as these contractors are regarded as an employee for tax purposes only. Despite the exclusion of employee benefits, hiring contractors on an inside IR35 basis tends to be more expensive as opposed to hiring outside IR35, since there are significant additional tax burdens.
Contractors ‘inside’ the legislation tend to operate via an umbrella company, which directly employ contractors and function as intermediaries between the contractor and the end client or agency. Because umbrella companies give the contractors a legal employee status, they must also comply with the employment law.
If the contractor is ‘outside IR35’, they are considered self-employed, operating as a genuine business. What this means is that they are responsible for managing their own taxes.
For this reason, hiring contractors outside rather than inside IR35 is usually less expensive. You are also not required to pay for sick leave, pension, or other employee benefits. In addition, you will not be responsible to organise National Insurance for contractors, as they will take care of this themselves.
The benefits of hiring outside IR35 are easy to reap, if you know your candidates are on the same page with you, from the start. Wellpaid.io is a platform that brings together developers and hirers who prefer outside-IR35 contracts. Save your time and find suitable candidates quickly by taking advantage of our outside-IR35-focused marketplace.
Questions to help you determine the status of a contractor
HMRC uses three indicators to help determine the worker’s employment status. As a hirer, you may do the same by asking the following questions:
- Control: Can you (the client) compel them to work at a given time, in a given location, and in a given manner?
- Substitution: Is the contractor alone responsible for their work, i.e., not allowed to send a substitute?
- Mutuality of obligation: Are both parties obliged to offer or accept work?
If you answered yes to one or more of these questions, your contractor may be classed as ‘inside IR35’. However, these determinations aren’t always unambiguous. It might be helpful for you to read more on the differences here or use HRMC’s Check Employment Status for Tax (CEST) tool. As a hirer, you can utilise the tool to:
- verify the accuracy of a determination you’ve received from your contractor
- use the determination as part of an off-payroll status disagreement process
However, it should be noted that the CEST tool has no guarantee of accuracy. The penalties for incorrect IR35 determinations can be steep; it is recommended that you consult an IR35 specialist to get legal reassurance of the IR35 status of your engagements.
How to find outside IR35 contracts
If you are a tech contractor, you might want to take a closer look at our blog post on how to find contracts outside IR35. To find the best outside IR35 contracts, apply for a free profile on wellpaid.io.
If you are a hirer, the wellpaid.io job board lets you find contractors outside IR35. The contractor database allows you to filter contractors by many different criteria to find a contractor to suit your company’s needs. Explore our marketplace of experienced IT contractors for free or sign up to save thousands on recruiter fees.