IR35 is a piece of tax legislation which looks to determine a genuine business from what we call a disguised employee. It targets personal service companies (limited company contractors) who may be working more akin to an employee of their end client rather than providing a genuine B2B service, and seeks to reclaim the additional PAYE tax and NICs that they would have paid as an employee.
When explaining IR35, we often refer to these two terms regarding your status, but what is inside and outside IR35?
In short, they indicate your IR35 status as being a genuine contractor (outside) or an employee for tax purposes (inside). The terms reflect whether you are operating within the legislation’s scope or not.
To be ‘inside IR35’ means that you are considered, for tax purposes, an employee of your end client and therefore subject to PAYE.
If you are operating ‘inside IR35’, you simply need to ensure that the appropriate taxes are being paid, which usually involves a ‘deemed payment’ of income tax being made at the end of the tax year (you should discuss this with your accountant) then you should ensure that your status is reassessed in the event of a change in your working practices, and/or when you begin a new contract.
If engaged to the public sector or medium-large private sector business, the fee-payer (usually recruitment agency) will be required to deduct your tax and NICs at source, however many agencies and clients are not set up to manage contractors through payroll, and therefore many will only engage you via an umbrella company, which acts as your employer (for a fee). Find out more about the off-payroll rules here.
Should you be found ‘inside IR35’ following an IR35 enquiry, HMRC will raise a determination for the income tax, NICs, interest, and potentially a penalty which should have been paid during the accounting period in question. This can run into the tens of thousands of pounds.
To be ‘outside IR35’ means that you are operating as a genuine business, and therefore operating outside of the IR35 rules.
If you are operating ‘outside IR35’, you are able to pay yourself a salary, draw the remainder of income as dividends, and remain responsible for your taxes as usual.
If engaged to the public sector or medium-large private sector business, your end client is responsible for determining your status, but if they have deemed you as ‘outside IR35’, then you will be paid your fee as normal and you will be responsible for managing your taxes as you would usually do.
Even if considered to be operating outside of the legislation, there remains the chance of an IR35 enquiry from HMRC. Enquiries can drag on for a couple of years and contractors, and often end clients, can innocently put their foot in it due to inexperience with HMRC inspectors. Seemingly clear-cut cases have been found to result with HMRC deeming the contractor inside IR35.
For both public sector contractors and private sector contractors providing services to medium-large organisations, your end client is responsible for determining your status. They are likely to be using HMRC’s CEST tool, or independent services such as Qdos’ Status Review.
Some end clients have been known to apply blanket determinations whereby they are simply placing all of their PSC contractors inside IR35 to avoid administration and liability concerns associated with the rules – this is not compliant with the legislation. Others are placing contractors based on their role (e.g. determining all nurses as inside IR35) which HMRC have deemed appropriate, however is fraught with issues when it comes to compliance with the legislation.
For private sector contractors working for small end clients, you remain responsible for your status. To determine your status, you should have your written contract reviewed for IR35 compliance and conduct an assessment of your working practices.
The way in which you actually provide the services is crucial, and whilst HMRC usually begin an enquiry by looking at the contractual terms, they will seek to clarify the terms directly with the end client. If your contract does not reflect reality, any positive elements of the agreement would have very little bearing in an IR35 enquiry. You should therefore always consider a review of your working practices when determining your status.
Despite changes in the administration of IR35, the tests used to determine status remain the same. Click the link below to learn more about these in the compliance guide.
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