IT contractors and freelancers who work long-term through limited companies need to ensure that their contracts accurately reflect the working practices outlined in their assignments, as HMRC may decide to “look beyond” your actual contract and examine working practices if they decide to query your IR35 status.
HMRC investigations are not confined to the detail contained in an individual contract, so contracts need to be carefully checked on renewal, and should provide clear evidence to support your status as a self-employed IT professional. If HMRC decides that your relationship with your client is of an employment nature, then they will seek to recover all income tax and National Insurance Contributions due over the period of the assignment covered by the contract.
What does IR35 mean?
IR35 is not new, it was actually introduced back in 2000 and was known as the “Intermediaries Legislation”. The original UK Government press release announcing the new rules was called Inland Revenue budget press release 35 – which is how the rules became known as IR35.
The IR35 rules are intended to ensure contractors working through an intermediary, such as a personal service company, pay a similar amount of income tax and National Insurance Contributions (NIC) as employees.
They came about as HMRC believes that many contractors, not just IT contractors, are in fact “disguised employees” and so are incorrectly describing their employment status as “self-employed” – up to 90% of contracts they believe.
As there can be significant differences between taxes paid between someone who is an employee and someone who is self-employed, HMRC is working hard to ensure a level playing field. They don’t want a situation where two individuals working side-by-side are doing a very similar job but being differently taxed. HMRC have stated that they believe the IR35 rules could affect up to 170,000 people who are working through a limited company.
What does it mean to be ‘inside IR35’
Being classed as ‘inside IR35’ means the service or work you provide is similar to a service of employment in HMRC’s eyes rather than a service of self-employment.
So, if HMRC deems you as being ‘inside IR35’ you will be considered as an employee for tax purposes, which will mean you will pay more tax than you would if you were ‘outside IR35’.
The three main principles used to determine IR35 status
How HMRC determine whether IR35 applies to your contract or not is quite a complex matter, but there are three main principles that they use:
- Supervision, Direction & Control: What degree of supervision, direction and control does your end client have over what, how and when you complete your contract and day-to-day tasks?
- Substitution: Can you send someone else in your place or are you required to carry out the work yourself?
- Mutuality of Obligation (MOO): Is your client obliged to offer you work and are you obliged to accept it?
These three principles remain the same whether you work in the private or public sector, and you will need to be able to demonstrate that they do not apply to your contract and working practices to avoid being affected.
If your contract with a client is a contract for services rather than a contract of services, then you will probably fall outside the scope of IR35. So, if you can send another person (a substitute) to perform the services outlined in your contract rather than having to complete them yourself, then there is no obligation for personal service and therefore IR35 should not apply.
Supervision, Direction and Control
Supervision, Direction and Control are part of the tests of employment that could prompt HMRC to place your contract inside of IR35.
- Supervision – is concerned with how your client oversees your work and whether you perform it to a standard they have specified
- Direction – is how your client directs the completion of your assignment, by providing instructions, advice and guidance as to how the work is meant to be done, coordinating with you as it progresses
- Control – is whether you have someone dictating the work to you and how you complete it – including the power to move you from one task to another as the business priorities change
Supervision, direction and control clauses should not appear in a contract, as contractors and freelancers should have control over how and when they work – not the client, in order to be classed as truly self-employed.
As a contractor, however, you will want to have a comprehensive Statement of Work that outlines:
- The services you will be providing
- Where these services are provided
- The billing mechanism – fixed price, day rate or hybrid
If your contract goes further and states that you must submit to management guidance, monitoring or appraisal, then HMRC will probably conclude you are under the control of your client and therefore, inside IR35.
Another test of employment is whether you are able to provide a substitute to complete the work on your behalf or reassign the work. The right to send a substitute must be absolute, and not restrictive. If you genuinely can provide someone else to do the work, then your contract should be deemed as being outside of IR35.
Mutuality of Obligation (MOO)
In order to qualify as being outside of IR35, there must be no mutuality of obligation, which would be determined by:
- An obligation for one party to offer work
- If work is offered, there is an obligation for the other party to accept it
In simple terms, a contractor must be able to work project-to-project with no obligation to carry on working for the client after their assignment is completed. A contractor should also have the right to terminate the contract partway through the project. On the other hand, an employee works specifically for a company and has an obligation to carry on working when their tasks are complete.
Your contract should also state whether you can take on projects from other clients at the same time, or whether the client can veto other assignments. If your contract specifies you can only work for one client, a certain number of hours on an ongoing basis and take whatever work the client throws at you, then HMRC will probably suggest that your contract is inside IR35.
Other factors that affect the IR35 status of a contract
Along with the three key areas highlighted above, you should also be aware of the following:
- How you are paid
- Is the equipment you use the clients or yours?
- Where will the work be performed?
- Corporate involvement
- Financial risks
- Employee type benefits
- Part and parcel
- Intentions of the parties
If you have any further questions about any of the IR35 reforms, please feel free to email Jonathon Webley (Managing Director) at email@example.com or ring him directly on 0161 416 6634 or 07941 798 021.