Many people choose self-employment for more freedom, such as the freedom to work flexible hours, choose projects, or even combine work and travel.
But sometimes, the difference between self-employment and employment gets a bit muddled. When it comes to paying tax, IR35 is tax legislation that helps ensure self-employed people and employed people pay similar levels of tax. Here’s everything you need to know about IR35.
What is IR35?
IR35 is a piece of legislation that addresses whether contractors or freelancers operating through an intermediary should be classed as employees for tax purposes.
For example, if you’re an employee, you make Income Tax and National Insurance contributions through your salary. But if you’re the director of a limited company, you have some choice around how you pay yourself.
For that reason, the director of a limited company and an employee doing the same work for the same company could have noticeably different tax bills.
Through IR35, HMRC aims to close this gap, so that employees and independent contractors pay fair taxes. If a freelancer or contractor isn’t considered an employee for tax purposes, they’re outside of IR35, meaning they can continue paying tax and claiming expenses through their limited company.
What does inside and outside IR35 mean?
Your IR35 status dictates whether you’re treated as an employee or contractor for tax purposes.
Let’s compare inside versus outside IR35:
Inside IR35 meaning: Your contract falls within the legislation. HMRC considers you an employee for tax purposes, so you’ll need to make the same Income Tax and National Insurance contributions an employee would through PAYE.
Outside IR35 meaning: You can continue to pay tax and claim expenses as a self-employed person. For freelancers or contractors working out of their own limited company, that means filing company accounts and paying taxes via Self-Assessment.
Whether you’re inside or outside IR35 legislation, you need to get your status right. Non-compliance with IR35 can lead to penalties. If HMRC determines that you should be classed as an employee instead of a contractor, you’ll be required to pay the tax and National Insurance due, and any interest on these amounts.
If HMRC determines you haven't taken reasonable care completing tax returns and paying National Insurance, you may also have to pay a penalty. This penalty is based on a percentage of any unpaid tax and National Insurance based on HMRC’s determination.
Since April 2021, it’s been down to clients to determine their contractors’ IR35 statuses. Let’s explore how HMRC assesses your status.
HMRC classifies you as an employee for tax purposes if your contract with a client falls inside IR35. This means your client or ‘employer’ is responsible for deducting Income Tax and National Insurance contributions from your fees.
They will also be responsible for determining your employment status and need to provide a Status Determination Statement (SDS), detailing their reasons for the status decision.
An accountant or bookkeeper can help you with IR35 compliance. If you have questions or need more support with working inside IR35, speak with an advisor as soon as possible.
HMRC’s Check Employment Status for Tax (CEST) tool can also help you understand how IR35 affects you. Some HMRC criteria can further explain what is inside IR35 – we’ll come onto this later in the guide.
Outside IR35 meaning
If your contract with a client falls outside of IR35, you can continue paying tax and claiming expenses through your company. Client contracts where you’re ruled as a contractor or freelancer, instead of an employee, are exempt from IR35 rules.
This means you can pay yourself a salary, draw income as dividends, and remain responsible for your tax reporting.
How to know if you are inside or outside IR35
Determining IR35 status can be complicated. You may benefit from the advice of an accountant or bookkeeper, who can help you stay compliant with IR35 rules.
Certain factors can influence your status. HMRC uses the following criteria to assess what is outside IR35 and what is inside the rules:
- Right of substitution: Do you have to complete the work personally? If you can’t swap in another team member, this could mean you’re more likely to be viewed as an employee and so you’d fall inside IR35.
- Right of control: Do you have control over how the work is completed? Self-employed people often have control over when and where they work. Requirements to work specific hours or work on company premises could indicate the contract is inside IR35.
- Mutuality of obligations: Is the company obligated to offer work to you, and are you obligated to take it? Employers are obligated to provide their employees with a continual stream of work while they’re in employment. Self-employed people are not obligated to continue working once the contracted work is delivered.
HMRC will review the terms of the written contract where available, and evaluate the working practices you have in place, too. Note: if you work for a small business, you’ll be responsible for determining IR35 status yourself.
The law is nuanced and cases are reviewed on an individual basis. A recent case against the Professional Game Match Officials Limited (PGMOL) became increasingly complex, as it was debated whether companies are obligated to provide referees with work – making them employees under the mutuality of obligations criteria.
Even if some of the criteria resonate with you, it doesn’t guarantee you’re working inside or outside of IR35 – though it is a useful indicator.
The difference between inside and outside IR35 isn’t always easily spotted, so talk to an accounting professional if you’re unsure.
Navigating IR35: Tips for contractors and businesses
Having a clear contract and working agreement with your clients can make it easier to determine whether you’re inside or outside of IR35. Review them individually, so you know where you stand with each client.
Make sure you keep records of your working practices, too. Should HMRC choose to investigate your case, you’ll need evidence supporting your IR35 status.
If you run a business that hires people working through an intermediary, remember that you’re responsible for determining IR35 status on their behalf. And if they’re working inside IR35, you’ll need to deduct Income Tax and National Insurance contributions from their fees, too.
HMRC assesses IR35 on a case-by-case basis, so it may be difficult to determine your status alone. Reach out to a trusted advisor for more support – you can find them in our advisor directory.
Disclaimer: Xero does not provide accounting, tax, business or legal advice. This guide has been provided for information purposes only. You should consult your own professional advisors for advice directly relating to your business or before taking action in relation to any of the content provided.
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