By introducing IR35, HMRC aimed to prevent contractors from providing services to a client where, if not for their own limited company, they would work effectively as employees. The publicised background of IR35 refers to the so-called ‘Friday to Monday’ scenario, whereby a worker could leave a job on Friday only to return on Monday to be doing the same work for the same company, but, as a contractor working via their own limited company paying a dividend as opposed to earnings, which would incur less tax payments. In other words, it’s designed to prevent ‘disguised employment.’
Read more about what IR35 is and how it came about
IR35 has been in existence for nearly twenty years. Prior to the inception of the legislation in 2000, workers operating through their own limited companies were able to receive payments from their clients to use as revenue, just like any other small business would. The profits could then be paid as dividends, saving the worker tax by reducing their PAYE and NIC payments.
In the 1999 Budget, however, it was announced by Gordon Brown that measures were to be introduced to combat tax avoidance through the use of ‘personal service companies,’ and as a result, the Intermediaries Legislation, otherwise known as IR35, was enforced in April 2000.
For those of you wondering, the term ‘IR35’ refers to the title of the press release distributed by HMRC (formerly Inland Revenue).
Since its arrival, IR35 has been heavily criticised, namely due to its complexity, its opinion-based nature and the many grey areas it covers. The key ‘tests’ on whether the IR35 legislation applies are based on the case of Ready Mixed Concrete Ltd (1969). This case was conducted under the National Insurance Act 1965 where the Minister of Pensions and National Insurance determined the contractor to be an ‘employed person’ based on the three key employment tests. The tests which were specified in this case are:
- Personal service - is the working arrangement a personal one or does the contractor provide a business to business service?
- Control - does the worker fall directly under the control of the engager or does the individual dictate how the work is carried out?
- Mutuality of Obligation (MoO) - is there a mutual obligation for the client to provide consistent and paid work and an obligation for the individual to accept this work?
To this day, these tests remain the specific criteria for many employment status cases and IR35 cases.
Read more about the different status tests here.
In 2017, HMRC introduced unpopular reform to the legislation which saw all public sector bodies become responsible for setting the IR35 status of the contractors they engage. As part of these changes, the IR35 liability transferred from the contractor to the fee-paying party in the supply chain, which is often the recruitment agency. This means that contractors no longer set their own IR35 status in the public sector and do not carry the liability for any mistakes.
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As if IR35 were not complex enough, further changes were introduced as of 6th April 2021, tweaks to the legislation now see medium and large clients in the private sector placed in charge of IR35 decisions, much like in the public sector. The new off-payroll working rules also see the fee-paying party carry the liability.
We advise all contractors to discuss the IR35 status with their client and or their recruitment agency. In doing so, contractors are better placed to have their status assessed fairly and accurately by the companies they work with.
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Contractors operating outside the scope of IR35 are able to pay themselves marginally more tax efficiently, usually through a combination of salary and dividends. In simple terms, clients pay the contractor, who will maintain responsibility for their taxes, just like any other small business owner.
A contractor considered ‘caught’ or ‘inside’ of the IR35 legislation would mean all income received within the period of the investigation is reclassified as employment income and, as a result, it is subject to PAYE, NIC, interest and penalties. It is therefore advised that contractors ensure they consider their own IR35 compliance by having their written terms and conditions and working practices checked regularly.