There has been a lot in the media lately about the IR35 changes and how it is the end of contracting as we know it. But what has actually changed? And how do you make sure you retain the tax status you believe you are entitled to?
“…the end hiring company is now required to make the decision and suffer the consequences of getting it wrong…”
IR35 has been around since the start of the century, and it has had various tweaks and changes in interpretation since then. But arguably none have caused the media attention and hyperbole of the current changes, which came into effect in April 2019 for the public sector and now come into effect in April 2021 for the private sector.
But what has actually changed? The truth is, it might be less than you think. The basis of an
IR35 determination, and the key questions to be answered to make that determination are still exactly the same. All the same factors still need to be looked at and weighed up to decide if a contractor is really running a business, or are they just an employee seeking to use a limited company to gain a tax advantage?
What has changed is where the onus for making that decision lies, and with it, who is liable for getting it wrong. Previously it was up to the contractor to decide, on a contract by contract basis, whether or not they were really acting as an employee for the end hirer. And if HMRC disagreed with the decision it was up to the contractor to argue their case and possibly pay back taxes and penalties if they lost. Since the changes the end hiring company is required to make the decision and suffer the consequences of getting it wrong.
Many employers have started advertising contract roles as either inside or outside IR35. This in itself is not entirely a bad thing – at least the contractor knows where they stand. However it does rather ignore the key question of IR35. That is, is the contractor genuinely in business or are they a disguised employee? How can you decide whether someone is genuinely in business when you don’t even know who that person is yet as you haven’t yet hired them?
“…is the contractor genuinely in business or are they a disguised employee?”
What this means is that the IR35 status advertised with a role may turn out to be incorrect. There are two sides to this coin. On the one hand, if you believe you are genuinely in business and you see a role advertised that you believe you are perfect for you needn’t give up just because it is advertised as inside IR35. See IR35 – Why you still have a voice
for advice on how to negotiate with an HR department who has made a determination before they have all of the facts.
On the other hand, there is no guarantee that a role advertised as outside IR35 will actually
end up that way. If the HR department is doing its job properly they will assess the candidate’s circumstances after they have been selected and make a determination on all of the evidence that is now available.
This where, as a contractor, some advance preparation is highly recommended. What is important is that you understand how IR35 works and you ensure that you run your business in an IR35 manner.
So what are the rules and what do I need to do?
At its heart IR35 is asking the question, is a contractor really in business for themselves, or are they just a disguised employee? If they are really just an employee they should be taxed like an employee. There is no one factor that determines if someone is genuinely in business of not, there are a range of different things that need to be considered together to decide, on the whole, is this person and employee or not? We look at the main factors below and what you should do about them.
The number one determining factor in distinguishing between an employee and a business providing a service is how much supervision, control and direction is provided by the hirer. If you are told what you need to deliver, but you are allowed to go away and make your own decisions on how you will deliver it then you are likely not an employee. However if you are supervised and instructed on how to do the work, as well as what work to do then you will be inside IR35.
“…how much supervision, control and direction is provided by the hirer…”
As with most of IR35 the key here is with your contract. HMRC and the courts can’t stand in the corner of the office and watch how much direction you get from supervisors, but they can look at your contract.
Your contract should specify in detail exactly what you need to deliver, including key milestones and dates along the way. However it must not say anything about how you are to do the work or supervision of the work as it is being done. Similarly, while you should have deadlines to meet, it must not say anything about the hours you should work or where the work must be done. These must be left up to the discretion of the service provider. Finally there must be nothing about performance reviews. You should be judged purely on what you deliver, not how you deliver it.
2 - Right of Substitution
Right of substitution has always been a key factor in determining IR35 status. When you hire an employee you expect that employee to turn up to work each day. They can’t send someone else instead. However when you contract to get a piece of work done you don’t care who does the work, as long as it gets done. This is the right of substitution.
In the early days ‘IR35 friendly’ contracts always included a clause saying that with the hirer’s permission the contractor could send an appropriately qualified substitute in their place. However HMRC eventually successfully challenged this by arguing that these contractors all worked for single person companies. Although the contract says you can send someone else the reality is you don’t have anyone else, so the clause is a sham.
The response was to interpose the recruitment agency between the contractors company and the end hirer. So the hirer contracts with the recruiter, who does have alternative people that can be substituted for the contractor. This is why savvy hirers will always insist on contracting through a recruiter, even if the actual engagement is soured directly with the contractor.
3 - Mutuality of Obligation (MOO)
In an employer / employee relationship the employer is obliged to continue to find work for and continue to pay the employee while the employee is obliged to continue to turn up to work for their prescribed hours. This is mutuality of obligation and it is a strong indication that someone is really an employee, not an independent business providing a service.
Therefore ‘IR35 friendly’ contracts will always specify what needs to be delivered, and they can specify when it needs to be delivered by, including interim milestones. However contracts should not specify that the contractor will be given work for a specific period as this would create a mutual obligation for the contractor to work for that period and for the hirer to find work for them to do.
People in the business of providing a service usually provide that service using their own
equipment. Employees usually work on kit provided by the employer. In reality most contractors will have a computer at home that they could do the work on, but for data security reasons it is common for employers to require work to be done on their own network.
5 - Risk and Responsibility for fixing errors
In reality there is generally very little financial risk for a personal services contractor. However the contract can specify that if the delivered produce does not meet the required standard then the contractor is required to rectify it without additional remuneration. This would provide a strong indication that his is not an employee.
“…your contract should specify that you will be paid X for delivering Y…”
Employees are paid for the time they spend at work while third party service providers are paid for what they deliver. So it is helpful if your contract can specify that you will be paid X for delivering Y, potentially with monthly progress payments along the way, rather than an hourly or daily rate. However legal and accounting firms often charge based on hours spend on an engagement, so while this can be a compelling indicator it is by no means a deal breaker.
7 - Part of the Furniture
This is basically saying, does the contractor act like an employee? That is, do they have the same access to all of the facilities and perks, attend the social events and staff meetings and just generally behave and get treated like another employee? If it walks like a duck and quacks like a duck there is a pretty good chance it is a duck.
“…If it walks like a duck and quacks like a duck there is a pretty good chance it is a duck…”
The key here is to ensure that your contract does not specifically give you all of the perks and entitlements that a contract of employment would.
A genuine business will generally have a number of clients, whereas an employee usually only has one employer. If you only have one client a good tactic here is to be able to demonstrate that you are actively seeking other clients. Have a business plan that involves multiple clients and a company website touting your company’s services. In other words, act like a genuine business. This will make it far more difficult for HMRC to argue that you are not.
“…acting like a genuine business is key…”
9 - The intention of the Parties
Again this is where acting like a business is key. You should be able to demonstrate that you
have a business plan, a marketing strategy, a finance system (spreadsheet is fine) and anything else that a genuine business in your line of work would be expected to have. If you can do this you can show that it was your intention to operate a business.
If circumstances dictated that you ended up with only one client, and you were with that client for a long time, well that’s just the way the cookie crumbles. Sometimes things don’t go exactly to plan.
Hopefully you will never end up in court having to defend your IR35 determination. However it is likely that you will find yourself arguing with an HR or legal department about your IR35 status. If you have considered all of the above points and can demonstrate that for most of them your behavior and circumstances indicate business rather than employee, then you have a good change of receiving an outside IR35 determination. Just remember that no one factor is a deal breaker, all factors need to be taken into account to decide on an overall picture.
Finally, if you’ve done all of the above and your hirer has still decided that you are inside IR35 remember that there is an appeals process. Hirer’s are required to provide you with an IR35 ‘status determination sheet’ which outlines the basis for their decision. You should base your appeal on the contents of this. Once the appeal is lodged the hirer has 45 days to respond.
As a contractor it is vital that you are aware of all of the above so that you can understand how works IR35 and be able to fight your corner if necessary. HMRC also provides a tool called CEST (Check Employment Status for Tax)
. HMRC acknowledge that this tool is not perfect, and if you wind up in court you would not be able to rely on its decision. However HMRC have stated that if the answers given are factually accurate they will stand by what it says. Now that you know how IR35 works you can improve your chances of CEST making the decision you want.