IR35 is the shorthand name (taken from the reference of the statutory instrument which introduced it) of the Intermediaries Legislation. Introduced in April 2000, this legislation is intended to separate “disguised employees” from genuine contractors, and to tax the former as though they were employees.
IR35 was introduced against a background of political and media concern over what was seen as an epidemic of employees leaving posts only to do the same job as a self-employed contractor. This was felt to be a dodge both for the employer to avoid paying Employer’s National Insurance Contributions and for the individual to take advantage of the more friendly corporate tax rates to reduce their personal taxes.
The concept was simple, a set of tests to be applied to a contract role that would determine whether the individual filling that role was in business on their own account, providing services to a client, or was in effect an employee of the end client. In the case that they were not operating a “genuine” business, the individual should be taxed in the same way as an employee – paying Income Tax and National Insurance on all income from that engagement. In practice the clarity of IR35 was muddied by poor communication from the then Inland Revenue (which got no better when it became HMRC), misunderstanding bordering on panic from many contractors, and accountants, umbrella companies and others capitalising on the confusion to sell “solutions”.
First Things First – who is affected?
The Intermediaries legislation is specifically targeted at a group of individuals, those working through what is defined as an intermediary. This means that IR35 definitely does not apply to you if you are:
- An employee on payroll at the organisation where you work, even on a fixed term contract – all of your tax liability is taken on a PAYE basis before you receive your pay.
- Self Employed – If you are working as a sole trader all contracting income should be declared on your Self Assessment Tax Return and will be assessed for Income Tax and National Insurance. IR35 does not apply as you are not working through an intermediary. In practice this setup is rare since agencies are forbidden from engaging with sole traders and end clients prefer to avoid it since contracting with an individual can be interpreted as a de facto employment relationship.
- Contracting through an umbrella company – if you work through an umbrella company you are an employee of the umbrella and subject to PAYE on your income from them. Many umbrella companies advertise themselves as “IR35 compliant” but this is misleading since IR35 simply does not apply to umbrella employees.
IR35 only applies to those working via an “intermediary” as defined in the legislation. In practice this means the rules apply if you are working through:
- A limited company (Personal Service Company, or PSC)
- A limited liability partnership (LLP)
If you work through one of these structures then you will need to consider how the Intermediaries Legislation affects the roles you take and if necessary arrange your affairs accordingly. A PSC is most common, so this guide will talk about PSCs, however the information applies equally to LLPs.
It is important to remember that IR35 does not apply to companies or individuals, but rather to engagements (that is individual contracts). Each role you take should be assessed, both in terms of the contract terms and the actual working practices that you follow. A simple summary of the tests would be to ask whether the role would be that of an employee at the end client if you weren’t using your PSC. Thus we talk about a role being “inside” IR35, where the role is deemed to be “disguised employment” or “outside” IR35, where the role is a contractual agreement between two companies.
The impact of being “inside” IR35
The outcome of working a role in scope of IR35 is that any payment for that role received by the intermediary is classed as a “deemed direct payment”. This means that it is assumed by HMRC to be a salary payment for the individual completing the work and is expected to be taxed as such. How this works in practice differs for the public and private sectors.