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IR35 and Off-Payroll explained – a simple beginner’s guide

In the contracting world, IR35 is a mythical beast.

Both new and seasoned contractors have heard — and, possibly, read terabytes of content — about it. Many fear it. But there are also a lot of misunderstandings around how it works and its impact on your bottom line.

So what is IR35, exactly? And how have controversial changes to IR35 (the ‘off payroll working’ rules) changed things following their introduction in April 2021?

Here is our beginner’s guide to IR35 and Off-Payroll.

What is IR35?

IR35 is the term given to a set of tax avoidance rules that crack down on ‘disguised employment’. If your work falls within its scope, you’ll be treated as an employee for tax purposes, even though you’re self-employed.

IR35 takes its name from Inland Revenue Press Release 35, the press release that announced the impending arrival of the Intermediaries Legislation over 20 years ago.

At the time, a growing number of contractors had started working through their own limited liability companies because it was more tax-efficient. But the government believed many contractors weren’t genuinely self-employed, but simply hid behind a corporate structure to pay less tax.

Enter IR35.

The press release put it this way:

“It is possible for someone to leave work as an employee on a Friday, only to return the following Monday to do exactly the same job as an indirectly engaged ‘consultant’ paying substantially reduced tax and national insurance.

“The Government is going to bring forward legislation to tackle this sort of avoidance.”

Who does IR35 apply to?

IR35 may apply if you provide personal services to clients through an intermediary – typically your own limited company, also known as a personal services company.

If you work via another type of intermediary – an umbrella company – then IR35 doesn’t apply, as you are already taxed as an ’employee’ of the umbrella company.

Is your contract work caught by the IR35 rules?

How do you know if your work is caught by IR35? The key thing here is to look at the overall picture – both the wording of your contracts, plus your ‘working practices’ (the way you carry out your contract work in reality).

Over the years, HMRC has developed four broad tests of employment. These are:

Who is in control?

Who gets to decide:

  • Where you work?
  • Your working hours and schedule?
  • Which tasks go on your to-do list? And can your client change the scope unilaterally without having to tweak the agreement?
  • Each task’s order of priority and how you actually do the work?

If it’s you, you’re probably outside IR35. But if it’s the client, you’re probably an employee and within IR35.

Can you send a substitute?

You don’t need to prove you’ve actually sent someone to do the work in your place to pass this test. But you must be able to show it’s a genuine right. In other words, the client shouldn’t be able to refuse your substitute except on reasonable grounds such as them being unfit for the job or not having the right security clearance.

HMRC’s Check Employment Status for Tax (CEST) tool also notes that, for the right of substitution to be genuine:

  • The client mustn’t have interviewed the substitute
  • You mustn’t have picked the substitute from a pool the client has pre-approved
  • The substitute must do exactly the same work you’d have done
  • You must have sent the substitute because you didn’t want to do the work yourself

Is there mutuality of obligation?

Mutuality of obligation means the client is contractually bound to give you work, and you’re contractually bound to accept it, irrespective of what it involves.

The courts have held that mutuality of obligation can arise simply if you keep renewing the same agreement every time it expires.

What’s your relationship with the client like?

The practical arrangements you have in place with your client may tip you into IR35’s orbit. In particular, there’s a good chance you’re in scope if:

  • The client provides the equipment you need to do the work
  • They’re your only client, or you need permission to sign up another one
  • You’re embedded into the organisation. Factors that point to this include attending staff meetings, having a profile on their website’s ‘Meet the Team’ section, and getting the same perks as employees

Who makes the IR35 assessment?

When IR35 first came into force, you, the contractor, were responsible for deciding if you were within or outside it. This changed in April 2017 (for public sector contractors) and changed again in April 2021 (for private sector contractors).

But let’s take one step at a time.

How did IR35 change in 2017?

In April 2017, the government issued new Off-Payroll Working Rules for the Public Sector. This shifted the responsibility for IR35 assessments in the public sector from contractors to public authorities.

Unfortunately, this new legislation proved complex and confusing. The Law Place’s Martyn Valentine said the new rules were:

“...an entirely different species of employment law and the depth of knowledge required to navigate it successfully exceeds both what is understood by professionals and what is conveyed through the assurance process.”

The upshot is that many public authorities made blanket assessments, applying IR35 even when contractors were genuinely self-employed. This increased costs, cut into contractors and intermediaries’ profits, and caused major disruption.

Andrew Chamberlain, Director of Policy at the Association of Independent Professionals and the Self-Employed (IPSE), put it this way: “The changes to IR35 have damaged the ability of public sector organisations to attract the talent they need and deliver projects on time.”

The new IR35 changes: what happened in April 2021?

Despite the unpopularity of the public sector changes, the government has decided to change the way IR35 status is assessed in the private sector too.

The government originally intended to bring in these reforms in April 2020. But, as part of the stimulus package to help businesses weather the Covid-19 crisis, the reforms were postponed by a year.

So what changed in April 2021?

As in the public sector, it is now the client’s responsibility to assess your IR35 status, unless they meet at least two of the following criteria:

  • They have less than 50 employees
  • Their turnover is less than £10 million
  • Their balance sheet total is less than 5.1 million

This is known as the small companies exemption.

Needless to say, these reforms have been as unpopular as the public sector reforms.

How would being within IR35 affect me?

IR35 can affect you in two ways:

  • You’ll pay more tax
  • If you’re responsible for assessing your IR35 status and HMRC finds your assessment was wrong, you’ll get fined

Working within IR35 is less tax efficient

Please note that the figures below should only be used for illustrative purposes!

Let’s say you earn £50,000 from a contract in 2023/24

If you work through your own limited company, your tax bill would work out as follows:

  • You take a salary of £9,100. This would mean you’d avoid paying income tax or national insurance, but qualify for national insurance credits
  • Your company pays Corporation Tax on profits, after salary has been paid. This is 19% x £40,900 = £7,771.
  • You take the remaining £33,129 as dividends. £1,000 of that is a tax-free dividend allowance, and £3,470 would fall within your tax-free personal allowance of £12,570. So you’d get taxed on £28,859 at 8.75%
  • This means your tax bill would be £2,507.66 in dividend tax, plus £7,771 in CT = £10,279 in total.

In comparison, within IR35, you’d have to take the whole £50,000 as a salary. So:

  • £12,570 is tax-free
  • The remaining £37,430 is taxed at 20%, that is £7,486
  • You’d also have to pay National Insurance at 12% on your earnings over £12,570, resulting in £4,492 worth of contributions

This means your total tax bill would be £11,978 — £1,699 more than what you’d pay outside IR35.

IR35 fines

If you’re responsible for assessing your IR35 status and you get it wrong, you’re on the hook for:

  • 30% of your unpaid taxes if the mistake was down to negligence or carelessness. Using our example above, that would be £3,593 on top of the £11,978 you owe in taxes
  • 70% if you knowingly made the wrong assessment, or £8,385 over and above your tax bill
  • 100% if you tried to hide your real IR35 status, which would effectively double your tax bill to an eye-watering £23,956

How can I make sure my contracts fall outside IR35?

While the IR35 reforms take the status decision out of your hands, you can still take steps to keep on top of IR35 and the Off Payroll changes.

Here are five things you can do.

1. Take out IR35 investigation cover

Tax investigation insurance is essential if you’re a contractor. This will cover any professional representation costs you incur during an HMRC investigation. Tax enquiry cover is very inexpensive – Qdos offers up to £50,000 of cover for under £100 per year!

2. Document your working relationship

If you believe you should be outside IR35, the best thing you can do is build a strong case for it.

Do you have control over your work, set your own hours, and provide your own equipment? Do you have a right to send a replacement worker? And is the client obliged to give you work (and you to accept it)? Your answers to these questions can prove you’re outside IR35.

It’s also worth gathering additional evidence that buttresses your position. This could include:

3. Discuss your situation with your client or recruitment agency

Accurate IR35 assessments benefit everyone.

Placing you outside IR35 could get your client or recruiter fined. But placing you within IR35 unnecessarily means the client has a less flexible workforce and higher costs, while the agency makes less profit.

With this in mind, it’s worth having a frank, open chat. Show your client or recruiter the evidence you’ve collected and explain why getting the assessment right is better than a blanket decision.

It may be useful to band with other contractors and approach the client or recruiter together. There’s strength in numbers.

4. Get everything in writing

A Confirmation of Arrangements is a document that:

  • Describes in detail the reasons you’re within or outside IR35
  • Confirms all the parties — client, recruiter, intermediary, and you — agree to your IR35 status

This is useful to have no matter who’s responsible for the IR35 assessment. It shows HMRC you’ve taken steps to comply, and also explains the reasoning.

5. IR35-proof your contract

Your contract is the foundation of your relationship with your client, so it’s worth tweaking it to make sure you’re outside IR35. Here are four clauses worth including:

  • An independent contractor clause that states you reserve the right to decide how, when, and where you work, and which specific tasks are within your agreement’s scope
  • A right of substitution. It’s worth exercising this on occasion and keeping proof, such as email trails
  • Boundaries. This includes working from your own premises wherever possible, and turning down any employee benefits
  • A non-exclusivity clause. This makes it clear you can work on other projects without seeking the client’s permission

It’s a good idea to have an IR35 specialist look over your contract, especially if the client or recruitment agency supplies the draft.

More to the point, you could have the most airtight contract in the world, but HMRC can have it set aside if your practical arrangements point towards you being an employee. With this in mind, it’s critical that your contract accurately reflects your working practices.

IR35 – what’s in a name?

As you will have seen, the term ‘IR35’ is used to refer to two pieces of legislation – both the original 2000 Intermediaries Legislation, plus the new ‘Off Payroll’ rules – which were applied to the public sector in 2017, and are set to be applied to the private sector in 2021.

The original legislation is included in Chapter 8 of the ITEPA – Income Tax (Earnings and Pensions) Act 2003.

The Off-Payroll changes are included in Chapter 10.

IR35 rules have changed. But there’s no need to panic

While there’s no denying that the law is fraught with problems, it’s not all bad news.

The key is to be proactive and tackle the challenge head on.

By reviewing your client relationships, setting clear boundaries, and showing you’ve embraced the flexibility and freedom of self-employment, you can give yourself the best chance of preserving your ‘outside IR35’ status.

Protect yourself against an HMRC IR35 investigation

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Last updated: 24th February 2024