What is IR35? Am I inside or outside? Help!
We’ve put our IR35 guide together out of pure and simple need. The legislation’s definitions are ambiguous. The line HMRC draws between employees and the self-employed can get blurred.
As such, the questions many contractors ask, before we’re even properly acquainted, are:
“Help, I may be inside IR35! If I am, how do I know? Then, how can I get out?”
There is no single answer. As such, our guide hopes to help you achieve three things:
- to understand what IR35 is in plain English;
- to determine whether you’re inside (ouch!) or out;
- take practical steps to remain compliant, thus outside of IR35.
The fact that you’re inside IR35 may well be the reason you’ve landed here today. Just realise, it’s not the be all and end all of your business. But if the tax man is already investigating you, do make sure you get in your accountant’s good books. 😉
Two things you must do whilst under investigation by HMRC
Whilst under investigation, there are two things you must do. First, carry on working! Your tax status doesn’t affect your ability to perform your established role.
Even if you are inside (IR35, not prison), that doesn’t mean the end of all tax benefits. Reduced, yes, but not all. So do prepare yourself: your new employment status will compromise your tax efficiency.
The second thing you should consider is contacting Qdos Contractor.
Qdos are leading experts in everything IR35. The team has supported UK contractors and freelancers for over a decade. They specialise in IR35 compliance and business protection and have done since IR35’s inception.
As such, Qdos have built an entire suite of products and services to tackle this legislation. It’s all aimed at achieving compliance and protecting any potential IR35 liability.
From the beginning: what is IR35?
The government introduced IR35 in 2000 as a bolt-on to HMRC. Its purpose was to investigate the self-employed who were gaming the UK’s tax system.
Contractors were the main target of “intermediaries legislation”, to give IR35 its working title. To be more precise, it targeted those who were, for all intents and purposes, an employee.
What does the profile of an IR35 contractor look like?
An IR35 contractor would work the same hours doing the same jobs as employees of the client. But rather than go onto the client’s payroll, they’d use their own limited company to get paid. Or an intermediary, an agency or umbrella company, that handled this way of contracting.
The only difference between the two workers would be the payment vehicle:
- the employee would be on payroll, paying tax and national insurance at source (PAYE);
- the contractor’s pay would go into their limited company and taxed at a later date.
What’s the difference if they both pay tax?
Well, HMRC avails limited companies of many more tax breaks than PAYE. In the eyes of IR35, such contractors only work this way as a tax dodge.
We know there’s more to it than that, with benefits to both client and contractor alike. But just you try telling the tax man that. 😉
Even though we now understand what HMRC introduced IR35 for, there’s still a huge grey area.
The problem is that many contractors don’t know their own employment status. Moreover, the problem it could cause them.
It’s the industry’s firm belief that 6 in every 10 contractors operate in a state of limbo. That is, should HMRC investigate them, the outcome could go either way.
Yes, 20% of contractors know that they’re “definitely contracting” (i.e., outside IR35). A similar 20% know that they’re not (i.e., inside IR35).
That’s one helluva lot of contractors living on the edge. The “it’ll never happen to me” maxim springs to mind, eh?
How does the taxman work out if you’re inside IR35?
The Revenue builds up a forensic picture of all parties involved in an investigation. Their focus is on inter-connecting relationships, often the biggest tell-tale sign of ‘being inside’.
This includes the existing contractor/client relationship and, in many instances, any pre-existing relationship.
It’s the pre-existing relationships that are key. Especially if you’ve worked as an employee for your client before going solo. Here’s why:
One scenario typifies why intermediaries legislation came into being above all others. An employee who’d cottoned on that contractors doing the same job as them took home more would:
- sit down with an amenable boss and put their case forward;
- negotiate a way to undertake their existing role but as a self-employed entity;
- quit their “employed” status, then return as a contractor to take on the same role;
- carry on as before, but invoice their gross pay through an agency or their own limited company.
This suited both parties. It absolved the employer of obligations to pay national insurance and calculate PAYE tax. In return, the new contractor could offset much more against their annual tax bill.
What few foresaw was the government’s gritty resolve to quash this practice. In the eyes of HMRC, this is not contracting; this is becoming a disguised employee.
Using dynamic pieces to build a picture
A history between two parties will not be the only factor HMRC considers. How a contractor conducts their business beyond main client activity is another big factor.
IR35 teams don’t judge each piece of “evidence” on its own merit. Rather, they paint the whole picture first, then arrive at a verdict.
Each factor present has a weight against the overall scenario, but in unequal measures. The degree attached to each factor is perhaps more pertinent than it being present at all. And it’s this variance in weights that makes IR35 so ambiguous.
Let’s ask you one question:
Take your current contract with your current client. If you swapped that contract for an employed role, would it influence the way you operate?
The closer to “No!” your answer is, the more likely it is that you are working inside IR35.
How to prevent being caught by IR35
To remain outside IR35, you must change the way you think about your role. To begin with, you must be able to distinguish whether you’re providing a service or a skill.
Don’t forget, you are operating through a limited company. As such, your client is engaging the company, not you as an individual.
Here’s a great acid test that you can carry out on any contractor business. If the company director cannot carry out their service in person, can they send in a substitute?
It might be easy to say, “Yes!”. But consider the consequences of an unskilled worker substituting for you for a second.
Your company is developing its brand, its reputation, all the while. How certain are you that a substitute would treat or uphold your reputation as well as you?
You’ve built the core principle of your business around your skillset. But as a limited company entity, you’re not just providing a skill. There’s much more on the line than IR35 if you expose your brand to unnecessary risk.
Other ways of proving you are a business
Another key aspect of business is advertising. But if you’ve not had a hand in marketing, the premise may seem alien to you.
It’s a safe bet that none of your previous employers encouraged self-promotion. And for sure: you may be working full time for the one client (there’s a hint!), so why bother?
If you’re happy submitting your timesheet every week, marketing may not seem necessary. In fact, there’s a good chance you don’t network (in a professional capacity). And investing in and maintaining a website?
But I’d ask you to think again.
Businesses don’t rely on one client. So to show your diversity, it’s a good idea to think about marketing yourself as a brand.
This isn’t only good business practice. It also helps prove that you’re a bona fide business, thus outside of IR35.
Grow your company brand
Those new to contracting are understandably budget-conscious in their first few years of trading. And as soon as we think ‘advertising’, we think ‘cost’, too.
If you have no budget to outsource marketing at the outset, you should still be networking. So many HR departments consult social media for ‘character references’, you can’t ignore it. Getting seen in the right places for the right reasons will open future doors for you.
Touting your business is an unnatural concept for the majority of contractors. You created your business to supply a service, not become a marketing guru, after all.
Yet finding a smaller project to run alongside your main one will prove that you’re not a one-trick pony. That’s without mentioning the benefits of extra income or new strings you can add to your bow.
How can you market yourself (without looking desperate or coming over as pushy)?
Become members of social media communities, such as those on LinkedIn and Google+. Join in the conversations (or start them) on Facebook and Twitter.
Search for business forums around your niche and contribute. You’ll feel amazing if you give someone advice based on your experience. You can’t put a price on that sort of testimony and all it’s cost you is a little time.
If you can’t provide answers, ask questions. Get involved.
For some, this is a tough ask. But it breaks the monotony of work, work, work. Many new to self-employment can find themselves toiling 16 hours a day. Give yourself (and others) a break.
Engagement like this may also help you discover industry sector pain points. Some you’ll know, others you’ll be unaware of.
By connecting with peers and sharing experiences, you’ll pick up workarounds for uncommon problems. There is no downside.
Go to trade shows and present your business cards to potential suppliers and customers. Get your face known in your industry.
“But my client likes me to be there 9-5!”
I hear you. And that brings us onto the next point…
You are the captain of your own ship, no one else
Clients! Can’t live with ’em, can’t live without ’em. But remember: when it comes to your business, you call the shots.
We’re not suggesting that you start dictating to your clients. That’s a surefire way of running your business into the ground. Too much attitude and you won’t need HMRC to pull the rug from beneath you.
However, do take complete control of your business’ destiny. Being firm and assured announces your intent, shows that you’re serious. It’s another degree of separation, helping prove you’re a business, not a disguised employee.
Work to your own schedule, within limits
You and your client will agree what you’re going to provide through your limited company. If you’re working on site, times are set by the client’s hours.
But if you’re working from home, maybe through an agency, it can be different. The only working time criteria should be the completion date. This is particularly pertinent to freelancers who work from one ad hoc project to the next.
If it’s a big project, tackle it in stages. Create milestones along the way, points to discuss progress and problems. Your client may even want to refocus the project’s direction at a juncture down the line.
If they ask for something beyond your skillset, don’t just turn the offer down. This is a great opportunity to outsource part of job.
Bringing in another specialist will help IR35 teams see that you are indeed a business. Offering secondary services can also help establish you as an authority within your niche.
Business is all about solving someone’s problems. The fewer people a client needs to go to, the greater value they’ll place on your service.
The time you spend working the project — office trading hours notwithstanding — should be down to you.
Logging your own hours for invoicing purposes demonstrates a degree of independence.
The only entity you’re exclusive to is your business
The more you can prove that you’re not exclusive, the sooner you’ll show that you’re outside IR35. Likewise, clients shouldn’t expect exclusivity of the use of your business.
It will help your cause if you’re working on two or three paid projects at any given time. For different paymasters, of course.
These could be JVs (joint ventures) or ad hoc freelance agency assignments. You don’t even have to do those in your working week. Work secondary projects at weekends if your main engagement fits around a 9-5 schedule.
Undertaking industry-specific learning is another way of showing that you’re in business to grow. Client mentoring has its place, but be careful. That could give the wrong impressions about your relationship.
Sometimes, a learning curve is part and parcel of a contract award. If so, have your client deduct a minimal amount for “training”.
Yes, it’s an expense you wouldn’t have to pay as an employee. But it’s tiny compared to HMRC adjudging you as receiving in-house training.
Obligation and Provision of Equipment
Providing your own tools of the trade demonstrates your independence. But sometimes, essential instruments and tools are on site and/or provided by the client. This can muddy the waters.
Provision of equipment is always an issue if you’re working on client-sensitive information. But your client won’t risk upsetting their customer just to meet your IR35 requirement.
They’ll be more concerned about the Data Protection Act for work under its jurisdiction.
In such instances, ask your client to provide a clause in your contract. Have them underline that no contractor-side tools are acceptable. Even better is asking the client to charge a small fee for equipment hire to help you carry out your service.
Do what you can to show that all work must be undertaken on site and using a client’s equipment. Highlight that without meeting this requirement, you couldn’t carry out your contract.
This all falls under the heading: proximity to client. If you can prove distance and independence, it’s doubtful that HMRC will try to use this against you.
IR35 teams will look for factors that suggest you’re “part and parcel” of a client’s business. In that respect, if you’re offered any of the following, you must politely refuse:
- invitations to company events and subsidised meals;
- expense or gift cards;
- security cards (unless specified as “contractor”);
- designated parking and/or company car;
- paid leave (holiday or sickness);
- off-site training grouped in with employees;
- pension contributions or bonuses funded from the company’s coffers.
Each may be tempting, but don’t risk them. They’ll only go to prove a relationship beyond your contract.
Pay, conditions and liabilities
Finally — and most obvious — HMRC will check out exactly how you’re paid.
Payment for a set amount of work, rather than on a day–, hour– or weekly rate, takes some getting used to. Especially if you’ve recently made the step up from permanent employment.
However, HMRC does count regular payments in its review. If your pay frequency mirrors that of a client’s employees, it will count against you.
If you’re engaged in a long-term project, break it down into achievable milestones. Each milestone should represent a pay-point as well as a deliverable on your part.
Your client should confirm this in your contract, alongside confirmation of your (non-)relationship. Both are extra work, but no one said going alone was going to be easy!
Operate like a business and you’ll be unstoppable
Ultimately, these measures aren’t meant to only benefit you from a tax inspection standpoint. They’ll help free you from the “on-the-clock” mentality.
In doing so, they also demonstrate good business practice. And that’s no coincidence.
Working towards production targets rather than clock-watching should boost your productivity and earning potential. Any restrictions on time are now as flexible as a Salvador Dali painting.
Also, there’s no obligation to hang around once you’ve reached a milestone. Raise the invoice and move onto the next stage or next client if you have to wait for feedback.
Finally, remember: IR35 tries to prove that you’re an individual entity, not a business. The best form of defence here is attack:
- surround yourself with your professional indemnity and liability insurances;
- register for VAT if your turnover warrants;
- invest in (necessary) computers and bespoke tools of the trade;
- create your Internet Real Estate (websites, blogs, social media profiles, etc.);
- order branded company stationery;
- prove your intent: act like a business!
And do hire a contractor-friendly accountant to prepare your books to a professional standard.
Yes, accountants are an expense that makes those new to contracting wince. But you’ll learn that a good accountant always saves you much more than they cost.
Just one last question: have you ever heard of a business without an accounts department? No? Neither has IR35.
Author: John Yerou
John Yerou is a pioneer of contractor mortgages and owner and founder of Freelancer Financials, Contractor Mortgages®, C&F Mortgages and Self Employed Mortgages, trading styles and brands of the award-winning Mortgage Quest Ltd.