How do contractors stay out of IR35?

IR35 is a piece of tax legislation announced in 1999, which came into force from April 2000. It is considered to be one of the main pieces of legislation affecting contractors and freelancers as its implications affect the way in which they are paid and their tax liabilities.  The legislation determines whether contractors are "disguised employees" or genuinely self employed, meaning that the Inland Revenue can tax some contractors as though they are employees of their clients if they are found ‘inside the IR35’.

HMRC’s aim was to track down the tax and National Insurance (NIC) avoidance schemes through the use of intermediaries, such as Partnerships or Personal Services Companies (PSC), by the contractors. They argued that if the agency or the PSC were removed, a large number of contractors would really be “disguised employees” who should be included on the client’s payroll and have their tax and National Insurance Contributions (NICs) deducted regularly.

IR35 uses tests of employment  to assess people’s working practices. Applying precedents from past tribunal and court rulings, where a worker’s employment status was being contested, the tests decide whether the worker is genuinely in business on their own account, or if they are a disguised employee. IR35 is applied on a contract by contract basis. If a contractor passes the tests of employment, they are deemed to be inside IR35 for a contract and are determined by HMRC to be a disguised employee, so then the contractor has to pay the income tax and NICs as if their contracting fee income were employment income.

 There are four main tests of employment to determine whether a contractor is a disguised employee and not genuinely self-employed as follows:

• Right to Control: if a contractor is told by their client where, when and how to complete the tasks allocated on their contract, they have passed the control test;

• Right of Substitution: if a contractor cannot send a replacement, or a substitute, to complete the tasks for the client on their behalf, they have passed the substitution test;

• Mutuality of Obligation : if a contractor expects the client to give them work, and the client expects the contractor to complete it, they have passed the mutuality of obligation test;

• Client Integration:  if a contractor becomes so integrated into the client’s organisation that they are behaving exactly like an employee, they have passed the client integration test.

If a contractor is determined to be “inside IR35”, namely they have failed the above tests, they will be required to pay the majority of their income as salary - this is referred to as their IR35 'deemed salary' and are liable for full PAYE and NIC's.

If you are a contractor or run your own business, you should get some expert advice and make sure you understand the implications of IR35. Please feel free to contact Belsize Accountancy for more advice on 0207 0430 052 or at info@belsizeaccountancy.co.uk.