What is IR35, and how does it impact your business?

IR35 has become somewhat of a buzzword in recent years, especially for businesses that hire or are considering hiring a contractor. However, we recognise that understanding what IR35 is and how it applies to your business can be a bit of a headache. 

That’s why we’ve put together this IR35 guide to help you better understand IR35 and what it means for your business and the contractors you hire. In this blog, we will answer the common questions surrounding IR35 to put your mind at ease and continue reaping the rewards of contract recruitment. 

What is IR35? 

IR35, otherwise known as the off-payroll working rules, is a tax legislation first introduced under the Finance Act by HMRC in 2000. The legislation focuses on combating tax avoidance by contract workers who offer their services to clients through intermediaries like limited companies and third parties - rather than being on the organisation's payroll as a permanent employee. IR35 was also established to uncover businesses that wrongly classify employed professionals as independent contractors.

These contractors, commonly referred to as 'deemed or disguised employees' by HMRC, essentially qualify as employees; however, they utilise their connections of being registered via an intermediary to avoid paying the appropriate taxes they were accountable for. HMRC will investigate a contractor's workspace and contract to determine if the individual falls inside or outside IR35 - something we will explore in more detail later in this piece. 

Ultimately, if a contractor is found guilty through IR35, they are classed as tax avoiders and must pay the funds they owe to HRMC. In contrast, the company who hired the contractor must pay any owed National Insurance Contributions (NICs) and income tax like a genuine employee.

What does inside IR35 mean?

A contracting position is deemed inside IR35 if the work or service provided reflects permanent employment, not self-employment, in the eyes of HRMC. In this scenario, the contractor would be liable to pay the same national insurance as an employed individual. As the contractor is subject to PAYE, the income tax and national insurance they owe to HMRC would be expected to be paid by the end of the tax year. If you are the end-user client who hired the contractor and failed to pay the correct sum of national insurance, you will be accountable for paying what you owe to the government.   

If a contractor operates in the public sector, the contractor agency or hiring firm will take the necessary income tax and national insurance from the contract worker's monthly pay. In contrast, within the private sector, the employer has a duty to determine whether their workers should be regarded as being inside IR35. A failure to provide an honest response would result in the employer paying a fee to HMRC.

What does outside IR35 mean?

Contractors and businesses that comply with IR35 are considered outside IR35. Here a contractor will have sufficient evidence to prove they work legitimately and earn their living through their limited company or intermediary. Although the contractor and the company that hired their services will have to ensure they pay the amount of tax and national insurance expected of them, they will not be penalised or be met with any additional fees by being outside IR35. 

Why is IR35 legislation more prominent today?

IR35 has become a more prominent obstacle in the contracting world in recent years, having laid almost dormant for the best part of two decades. As many as 90% of contractors considered themselves to fall outside IR35 and chose this option to avoid paying taxes, which HMRC estimated resulted in an annual avoidance of £1.3 billion in taxes. 

Of course, determining whether these contractors understood the legislation and decided to ignore it or didn’t fully understand the importance of IR35 is a debate of which no concrete conclusion could be made. However, off-paying IR35 reforms in 2017 and 2021 indicated a crack-down on the matter.

In April 2017, public authorities were made accountable for determining if the off-paying working rules applied to the contractors that provided their services via their own intermediary. This meant the contractor was no longer in charge of deciding their IR35 status. Instead, this was decided by the end-user client. So, if the end-user considered a contractor to be inside IR35, the contractor intermediary would be liable to pay the tax they owe as if the contractor was an employee.

Then in April 2021, after a delay due to the pandemic, new rules meant all public authorities and medium and large clients in the private sector were determined to be responsible for deciding if IR35 rules applied to them. For a smaller business that utilises the services of a contractor outside the public sector, the rules to determine the genuine employment status of the contractor are made through the intermediary. Essentially, like with the 2017 IR35 reform of the public sector, the IR35 status would be and still is determined by the client and not the contractor intermediary within the private sector. 

It was rumoured IR35 reforms would occur in April 2023, but this looks doubtful at this stage.

What does IR35 mean for your business?

As mentioned, if you are a medium or large business that utilises the services of contractors, you must set the IR35 status of the contractors you use. If the status set is deemed incorrect, penalties and additional fees will be handed out by HMRC. 

On the other hand, if your business is considered ‘small,’ then exemptions are in place. But what is meant by the IR35 small company exemption? 

According to the off-payroll legislation within the private sector, a small company is classed under the same criteria stated in the Companies Act 2006. Therefore the IR35 small company exemption applies to businesses operating within the following parameters:

• An annual turnover of no more than £10.2m
• A balance sheet of no more than £5.1m
• An average number of employees of no more than 50

A contractor's IR35 status of being ‘inside’ or ‘outside’ can be examined by HMRC at any given time, and the below three factors are always considered. 

• Control - this is determined by how much control your business has over the contractor. From what they work on to when and where they work on the project or assignment you’ve tasked them with completing. Essentially, the more control you have over the contractor, the more likely they will be considered inside IR35.
• Substitution - if your project or task requires a specific skill set or expertise of a contractor that can't be substituted or picked up by an employee within the business, then you will be acting compliantly outside of IR35. 
• Mutuality of obligation - this factor is in place to determine if you're obligated to provide work to a contractor and that the contractor has an obligation to accept taking on the work. If yes, then this could mean you're operating inside IR35.

Additionally, HRMC will factor in the type of contract you provide, if any financial risks are posed to the contractor, the contractor’s role within your business, to any equipment you provide to the contractor.  

How does IR35 impact contractors?

If a contractor is assessed and determined to be operating inside IR35, this could significantly impact their financial situation. As discussed, a ‘disguised employee’ would need to pay any unpaid income tax and national insurance as if they were employed by a business. Although they would be paying what they would if they were employed, they would still be exempt from the benefits a genuine employed professional would receive, from paid annual leave, sick leave and other employment benefits provided by the business.

HMRC can assess contracts as far back as six years ago. Therefore, if a contractor had been inside IR35 for that period of time, they could owe a substantial fee. Consequently, a contractor deemed inside IR35 could see their net income reduced by 25%.

Looking to hire a contractor? Talk to our specialists today!

We appreciate IR35 can be difficult to get your head around, but we hope this blog has been helpful. If you're still unsure about how IR35 affects you, we can help. We partner with Qdos to ensure our contract recruitment is IR35 compliant, so you can rest assured that when you work with us, you'll receive the best recruitment experience you will ever have.

At 3Search, we have a vast range of services to help you find the best contractors to help your business reach new heights. So, if you are considering hiring a contractor or would like to know more about how contractors can support your business, take a look at our contract recruitment offering or get in touch with a member of the team today.