If you work as a contractor in the UK, staying compliant with IR35 is essential — but it’s often easier said than done.
What is IR35?
IR35 refers to a set of tax rules that apply to ‘off-payroll working’. The Government first introduced IR35 legislation in 2001 to close a tax loophole where contractors would operate as ‘disguised’ employees in order to pay less tax. To address this issue, IR35 aims to make a distinction between ‘deemed’ employees and legitimate contractors.If a worker operates similarly to an employee, IR35 rules dictate they should pay the same amount of tax as someone on the payroll. This is known as being ‘inside’ IR35.
On the other hand, contractors ‘outside’ the scope of IR35 are treated as self-employed. Generally speaking, being a contractor is usually more tax-efficient compared to working as a deemed employee. According to a recent survey, freelancers and contractors are increasingly turning down work that falls within the scope of IR35 as a result. So while IR35 is intended to promote fairness, the subjective nature of the legislation means many business owners end up with a steeper tax bill than other businesses.
How does IR35 work in 2023?
When IR35 first came into effect in 2001, each individual contractor was responsible for determining their own employment status for tax purposes. In 2017, this responsibility shifted from contractors to the public sector bodies engaging them. The Government extended these rules to the private sector in 2021, so the burden of setting IR35 status and paying tax now falls on businesses instead of individuals — at least in most cases.
However, contractors still need to set their own IR35 status when working for small businesses. According to the Companies Act 2006, a firm is a small business if it has two or more of the following features:
- an annual turnover under £10.2 million
- a balance sheet of £5.1m or less
- fewer than 50 employees.
If you do work with smaller firms, you’ll need to know the difference between inside and outside IR35.
Am I inside or outside IR35?
If you perform services for a client through your business, IR35 could affect the tax treatment of your earnings — regardless of your business structure. To find out if you fall inside or outside the scope of IR35, you’ll need to determine whether you meet HMRC’s definition of self-employment.
There are multiple factors that might influence your employment status in the eyes of HMRC. Generally speaking, you’ll be considered self-employed (and therefore outside IR35) if your work meets all of the following criteria:
- your work is project-based
- you are not managed by your clients
- you don’t offer exclusivity to clients
- your contracts are linked to completion of services.
You usually won’t need to worry about this when working with larger clients, as the responsibility for determining IR35 status falls to them — but you can dispute their decision if you disagree with it.
Helping you stay compliant
If you are responsible for setting your IR35 status, we’d always recommend speaking to an expert first. Navigating off-payroll working rules can be complicated, and getting it wrong could result in a hefty bill and non-compliance penalty from HMRC.