A Guide to IR35

You may be surprised to know that the off-payroll working/IR35 rules were introduced as part of the 1999 budget by the then Chancellor of the Exchequer, Gordon Brown! Coming into force from April 2000, they became known as ‘IR35’ due to the rules being the 35th Inland Revenue news release of that budget, under the title ‘Countering Avoidance in the Provision of Personal Services’.
They were initially designed to tackle two main issues:

• The problem of ‘disguised’ employees who worked through a limited company (we’ll call them a contractor), rather than being employed in the usual way. By doing this, a contractor could set up a limited company, taking advantage of the reduced personal tax allowances where a company Director could take a salary below the minimum threshold of his/her tax allowance, and pay themselves dividends (as a shareholder) which were also tax free to a certain limit. They could also add their marriage mate onto the company and use their tax allowance to take even more money from the company… aah, the good old days!
• The ‘Friday to Monday’ scenario – where a company could have chosen to only employ workers through a limited company, which would then avoid them having to provide the worker with any benefits or protection, outside of the agreed contract. The company would also avoid paying the government and national insurance contributions on behalf of the worker.

Under these new rules, the government could review a contract between a Personal Service Company and its Client. If it was determined that the worker was ‘inside’ IR35, the worker being considered by the government an employee of the company, rather than a self-employed contractor, there would be some serious tax implications for both the firm and the contractor!

The short answer is “no”! In fact, if you became a contractor in the mid-noughties to mid-tennies, you may not have even been aware of IR35! There are two reasons why IR35 didn’t really tackle the problem as it was designed, and didn’t achieve the notoriety that it has done in recent years:

• The worker was responsible for their assessment – The original legislation could be worked around by a worker contracting their services to a client through an agency. The agency would work as a provider of resources on a ‘more than a single employee’ arrangement with the client, having a separate agreement with the worker and their Personal Service Company (PSC) which would ensure that the IR35 regulations were adhered to.
• Lack of government resources – 20 years ago, everything was done via hard copy paperwork and manual processes that were dependent on individuals. So, the process of investigating an individual company was laborious and the £’s recouped from a ‘disguised’ employee and the end client for their tax/N.I. contributions after an investigation were outweighed by the cost involved.

Following a change in government in 2010, the Office of Tax Simplification (OTS) was created by the chancellor George Osborne and, as part of their scope, IR35 was reviewed. Unfortunately, it was decided that this would remain in place and whilst some additional guidance and tools for determining status were introduced over the next few years, the returns for the government remained low and it continued to be ‘worked around’ by most.

As part of the 2016 budget, the government announced a ‘clampdown’ on the ‘off-payroll working’ within the public sector. These regulations came into effect from 6th April 2017 and public authorities became responsible for deciding if the contracted workers who provide services through their own intermediary were operating on an inside or outside IR35 basis. These changes made hiring contractors much riskier as, if the agreement with the contractor who had been working on an ‘outside IR35’ basis was investigated, and the contractor was deemed to be ‘inside IR35’, the public authority would be responsible for paying NI, and the contractor, their Tax and N.I. (plus any interest). As a result, organisations like the HMRC, NHS and the MOD no longer use any limited company contractors to avoid this risk.

From 6th April 2021, after being delayed for a year due to the pandemic, the same regulations were applied to the private sector meaning that end clients were now responsible for determining the IR35 status of a role, whether engaging a contractor via their PSC directly, or via an intermediary. Not all organisations are affected but if 2 of the following 3 conditions are met, then I’m afraid you or end client will need to be on your guard:

• The organisation has an annual turnover of more than £10.2 million
• The organisation has a balance sheet total of more than £5.1 million
• The organisation has more than 50 employees

Again, the impact on the private sector has seen most large organisations take a blanket approach to the IR35 challenge. Rather than using the CEST tool provided by the government to determine each role individually to assess whether it’s inside or outside IR35 and completing a Status Determination Statement (SDS) form to communicate this, most organisations only work with contractors on an inside IR35 basis.

There are 3 parties that are particularly interested in making sure that these IR35 rules are adhered to:

• A worker who provides their services through an intermediary
• A client who receives services from a worker, through an intermediary
• An agency providing workers’ services through their intermediary

When a role is ‘inside’ IR35, income tax and national insurance contributions must be deducted from any fees paid to the contractor and paid to HMRC. In addition, the end client needs to pay HMRC the equivalent employer’s national insurance contributions.
The introduction of this change in the private sector has had an impact on the overall contract market in 5 major ways:

1. A decrease in the number of ‘outside’ IR35 contracts available, although the day rates have stayed largely the same
2. An increase in the day rates of ‘inside’ IR35, of around 20-25% in the IT space, but even higher for more specialist roles
3. A reduction in the number of contractors, as the benefits of not being a permanent employee have been largely nullified by IR35
4. Increased labour costs for organisations, increased costs for contractors (despite the day rate increases) and a lot of additional revenue for the government!
5. The increased use of Umbrella companies, who generally run the payroll for individual’s working on an inside IR35 engagement, as well as providing other services e.g. insurance.

In the earlier years of IR35, the risk of an investigation was very low given the lack of government resources and the limited rewards even if an investigation was successful. However, with the advances in technology and the governments use thereof, large volumes of data can now be formatted, processed and analysed with the click of a button, if that in some cases! Therefore, the process of identifying companies that fall outside of an agreed threshold or fail to meet a set of criteria is far easier and, as a result, the risk of being ‘rumbled’ is increased.

In the old days, a worker would sign a contract on behalf of his PSC for his services over a set number of days, hours in those days, at a location and at an hourly or day rate, all specified by the end client, and it would still be ‘outside’ IR35 (as in, not subject to PAYE/N.I. contributions from the worker or the end client, although the term wasn’t really officially used then). In most cases there would also be a clause that prevented the contractor from working for another organisation whilst engaged with the end client. By today’s standards, that type of contract is 100% inside IR35!

When determining the IR35 status of a role, a number of factors come into play as to whether a role can be determined to be outside IR35. To prove yourself as truly ‘outside’ IR35, you basically need to demonstrate that you have more control over the when, where & how you work, the tools you use to perform the services and what work you’re required to do, than the end client. The CEST (Check Employment Status for Tax) tool provided by the government captures a lot of data about the role but uses the following key factors in determining the correct status:

Substitute Workers
Arguably the biggest factor in determining your IR35 status is whether or not you have control over the provision of a substitute. As it is effectively a B2B agreement between the PSC and the end client, or intermediary, the services are being provided by the company and not the individual. To this end, for the contract to be deemed outside IR35, a Contractor/PSC should have be able to provide an equally qualified ‘substitute’ candidate at their discretion. Of course, the substitute will need to be equally qualified and meet all of the client’s necessary vetting, security and interviewing requirements, but the PSC/Contractor has the freedom to have the final say on the substitute, and it is worded in the contract, then a big ‘outside’ IR35 box has been ticked. If the client can reject a substitute no matter what, the role is very likely to be deemed ‘inside’ IR35, even if the agreement meets all the other ‘outside IR35’ criteria.

Mutuality of Obligation

This term refers to the obligation, being the services or deliverables that a PSC/Contractor has been engaged for and who can make the decision about whether other pieces of work can be introduced as part of the same agreement. If mutuality of obligation exists, then this is an indicator of employment, rather than a contractor. Basically, if the contractor has to work on whatever the end client tells him to under the existing contract, whether that be agreed deliverables or otherwise, suggests mutuality of obligation. If the PSC/Contractor can say ‘no’ and only work on the existing agreed deliverables, with a new contract being created to cover additional services, then this suggests an outside IR35 arrangement.
To use project management terms to outline an outside IR35 arrangement, a PSC/Contractor would have control over the scope of the project/deliverables to which they have been engaged to provide. A change request would need to be raised for the additional scope and a separate estimate and fee would be chargeable by the PSC/Contractor and payable by the end client.

When and where the Contractor fulfils the obligations of the contract

Another smaller factor that can be used to indicate employment or an outside IR35 arrangement exists, is the hours at which a contractor is required to work, and the location at which they are required to carry out the work. The more control a worker has over when they work on the deliverables of the contract and where they do it, the less likelihood that it can be considered that the relationship is of an ‘employed’ nature. From a client perspective, all their permanent employees are likely to work between the hours of 8-6, and it would not be unreasonable of a client to request that project team meetings, daily stand ups etc are attended by the Contractor an perhaps insist that these are done face to face. However, if a contract contains a set number of hours a day, or days a week in a set office, then these factors can be used as being indicative of employment rather than engagement.

Exclusivity & other business operations

Following on from the ‘when and where a contractor is required to fulfil the obligation of the contract’ another indicator of an employed/inside IR35 status is exclusivity. If a PSC/Contractor only works for 1 client for an extended period of time, this could be used to indicate employment. To combat this challenge, running a PSC as a business, having a website, dedicated office space and employees will all point to you being a legitimate business rather than an employee. A presence on social media, advertising campaigns are all indicators of your company actively looking for additional work and therefore evidence of an outside status, even if you have only managed to get one client who you are working for. Even if you were working on another project within your existing limited company, e.g. development of a website in an industry that is disassociated with the one you’re contracting in, that would again be proof that you are truly self-employed and therefore an ‘outside IR35’ provider.

Financial Risk & Contract Structure

This is another major factor that can be used to determine if a PSC/Contractor is working as an employee rather than being self-employed. In order to demonstrate an outside IR35 arrangement, there should be some financial risk carried by the PSC/Contractor that is engaged. This can be achieved by structuring the agreement with the end client as a Statement of Work (SoW), containing specific deliverables that have a financial value attached as well as a deadline for completion. There could also be penalties added into the SoW if these deadlines were not met, or even bonuses where the deliverables are completed sooner than agreed.

By agreeing to this SoW, the contractor would be accepting the responsibility of completing the work to the required standard in the required timescale, or face the possibility of losing money by additional time spent and any penalties, which would satisfy the requirement of their carrying financial risk and the agreement being indicative of an outside IR35 arrangement. If a PSC/Contractor gets paid regardless of whether the deliverables are completed or not, this is evidence of a lack of financial risk and therefore an indicator of an inside IR35 arrangement.