How to stay ir35 compliant: a complete guide

Understanding IR35 Legislation

The IR35 legislation, introduced by HMRC, aims to tackle tax avoidance by targeting contractors who provide services to clients through an intermediary, such as a limited company, but would otherwise be considered employees if the intermediary did not exist. Essentially, the legislation seeks to ensure that contractors pay the correct amount of income tax and National Insurance Contributions (NICs) by assessing whether they are genuinely self-employed or operating as "disguised employees."

Staying IR35 compliant is crucial for contractors to avoid penalties, hefty tax bills, and potential legal action. This guide outlines how contractors can remain compliant with the legislation, the factors that determine IR35 status, and the steps that businesses and contractors should take to ensure they meet the necessary requirements.

How IR35 Works

IR35 applies to contractors who work for clients through an intermediary, such as their own limited company (often referred to as a personal service company, or PSC). The legislation distinguishes between two types of working relationships:

• Inside IR35: If a contractor is deemed to be inside IR35, they are considered an employee for tax purposes. This means they must pay income tax and NICs as if they were an employee of the client.

• Outside IR35: If a contractor is outside IR35, they are considered genuinely self-employed and can continue to benefit from the tax advantages of working through their limited company.

Since April 2021, medium and large private-sector businesses have been responsible for determining the IR35 status of contractors they engage. Small businesses, however, are exempt from these changes, and contractors working with them remain responsible for assessing their own IR35 status.

Key Factors That Determine IR35 Status

Several factors are used to assess whether a contractor falls inside or outside IR35. HMRC examines the nature of the working relationship between the contractor and the client, focusing on three primary areas:

1. Control

Control refers to how much autonomy the contractor has over how, when, and where they complete their work. If the client has significant control over the contractor’s tasks, working hours, and location, this may suggest an employer-employee relationship, meaning the contractor is likely inside IR35. Conversely, if the contractor has the freedom to decide how to carry out their work, they are more likely to be outside IR35.

2. Substitution

The right to provide a substitute is another key factor. If the contractor is required to carry out the work personally, this suggests an employment relationship. However, if the contractor has the right to send a substitute or hire someone else to complete the work on their behalf, this indicates a genuine business-to-business arrangement, meaning the contractor is more likely to be outside IR35.

3. Mutuality of Obligation (MOO)

Mutuality of obligation refers to whether the client is obliged to provide work and whether the contractor is obliged to accept it. If there is an ongoing expectation for the client to offer work and for the contractor to accept it, this may indicate an employment relationship, placing the contractor inside IR35. On the other hand, if the contractor can reject work and the client is not required to offer a continuous stream of projects, this suggests the contractor is operating outside IR35.

How to Stay IR35 Compliant

To remain IR35 compliant, contractors and businesses alike must take proactive steps to assess and manage the working relationship. Below are key steps to ensure compliance:

1. Conduct a Status Determination

Both contractors and clients should assess the IR35 status of each contract before work begins. For businesses, this is a legal requirement for medium and large enterprises. Contractors should also perform their own assessments, even if the client has already done so, to ensure they agree with the determination.

HMRC provides a Check Employment Status for Tax (CEST) tool, which can help both parties assess the contractor’s status. However, it’s important to note that the tool has faced criticism for its accuracy, so seeking professional advice may be a more reliable option.

2. Review Contracts Carefully

Contracts should be carefully reviewed to ensure they reflect the true nature of the working relationship. Factors such as control, substitution, and mutuality of obligation should be clearly addressed in the contract. Inconsistent or vague wording could increase the risk of being caught by IR35.

It’s essential that the contract reflects the day-to-day reality of the working arrangement. HMRC will look beyond the contract and consider the actual working practices, so ensuring consistency between the contract and reality is crucial.

3. Maintain Evidence of Working Practices

In addition to having a well-drafted contract, contractors should keep detailed records of their working practices. This could include:

• Emails that demonstrate their independence in deciding how to complete tasks.
• Evidence of the right to provide a substitute.
• Documentation showing the contractor has worked for multiple clients simultaneously.

These records can serve as valuable evidence if HMRC investigates the contractor’s IR35 status.

4. Seek Professional Advice

Given the complexities of IR35, many contractors and businesses seek professional advice from accountants or legal experts who specialise in employment status and tax law. An expert can help assess contracts, provide guidance on IR35 status, and offer advice on how to structure working relationships to remain compliant.

5. Stay Updated on IR35 Changes

IR35 legislation has undergone significant changes in recent years, and further amendments could occur in the future. It’s important for both contractors and businesses to stay informed about any developments in IR35 rules and how they may affect their working arrangements.

Consequences of Non-Compliance

Failing to comply with IR35 can have serious financial and legal consequences. If HMRC determines that a contractor should have been inside IR35 but failed to pay the appropriate tax and NICs, the contractor (or the client, in some cases) may face:

• Backdated tax and NICs payments.
• Interest on the unpaid tax.
• Penalties, which can range from 0% to 100% of the unpaid tax, depending on whether HMRC believes the non-compliance was careless or deliberate.

These penalties can be significant, and it’s vital to ensure compliance to avoid potential financial hardship.

Final Thoughts

Staying IR35 compliant is essential for contractors and businesses alike to avoid penalties and maintain smooth working relationships. By understanding the factors that determine IR35 status, reviewing contracts carefully, maintaining accurate records, and seeking professional advice when necessary, contractors can ensure they remain on the right side of the law.

While the legislation can be complex, taking a proactive approach to compliance will help both parties navigate IR35 with confidence and avoid any unpleasant surprises from HMRC.