IR35 is designed to deal with “disguised employment” whereby people worked as self-employed (and got all the tax advantages) but were in reality employed. Basically the government decided contractors and freelancers were trying to avoid tax while doing similar work to those permanent employees.
IR35 tax legislation was announced in 1999 (and IR35 itself was merely the name of the press release that explained the changes that would take effect in April 2000).
The government believed people were merely taking advantage of a corporate structure and were avoiding tax and National Insurance Contributions (NICS) by using intermediaries such as personal service companies or partnerships. IR35 has targeted circumstances where a worker would be treated as an employee of the client, if it were not for the existence of the intermediary.
Through these intermediary companies people would be paid a small basic salary and all other monies paid in dividends which incurred far less tax and NI. Where this structure was a limited company, the worker was able to take money out in the form of dividends instead of salary.
Dividends are not liable to pay NICs so workers would pay less than either a conventional employee or a self employed person.
From April 2007 the loophole that allowed managed service companies and composite companies to act as “intermediaries,” to avoid tax and NIC was closed. The IR35 rule says that if an intermediary was used and the relationship between the worker and their client would normally have been direct employment the worker should pay tax like any other employee.
Composite companies’ tax advantage has now ceased to exist, and the benefits of operating as one have been withdrawn. The only way now to gain the tax benefits is to demonstrate that you are genuinely self-employed (and thus stay outside IR35).
Who is affected by the changes of April 2007?
All contractors need to consider IR35, and whether they are in or outside it. Sole traders, legitimate freelancers or consultants who are genuinely self employed, or operate properly through a limited company will be outside IR35. It is the contractor’s responsibility to determine their tax status and IR35 legislation affects all contractors who do not meet the legal definition of self-employment.
Being caught inside IR35 depends on a number of factors and is determined by the contractors working relationship with the agency and the client and the contracts involved.
What exactly are the IR35 rules?
You have to be genuinely self employed to be exempt from IR35. If you do not meet the self-employment definition you will be “inside“ IR35 which means you will have to pay tax like a normal employee.
How do I stay outside IR35?
The key to this is the contract, which must reflect the reality of the situation in practice. You should ensure you are engaged under a ‘contract for services’, although this alone is not enough. You also need to show that the relationship between yourself and your client would have been one of self-employment if you had been working for them directly (for example with no recruiting company involved). To show self-employment, for example, perhaps you do not do the work directly yourself and have the right to send someone else, or you can do the work in your own time and/or wherever you choose and you can decide how you do the work as long as it is completed in accordance with the contract.
The above criteria are the main pointers towards genuine self-employment. But other factors can indicate self-employment, but not on their own. For example maybe work performed is specified in the contract and the client has no right to direct you to do other work.
Other minor indicators include signing the visitor’s book and having to obtain a visitor pass. Or being a guest or always giving advice as an independent consultation. But it is possible to be outside IR35 for one job and inside it for the next. By signing the form that says you are outside IR35 it is your responsibility to ensure your relationship with future clients also meets the self-employment test.
HMRC has issued guidelines and has issued its own guidelines on self- employment, known as IR56.
