IR35 and off-payroll working rules are special UK tax legislation affecting contractors providing services through intermediaries such as their limited company or a personal service company (PSC).

What is the purpose of IR35?

IR35 is designed to combat tax avoidance by contractors who supply their services through an intermediary but work effectively as an employee of their clients. Were it not for the intermediary like a PSC, they would be taxed as a typical employee. By working through their own company, contractors can pay themselves a mix of salary and dividends, resulting in less tax and NICs than being classed as an employee. IR35 dictates that contractors caught by the rules should pay similar taxes and NICs to regular employees. Otherwise, they gain an unfair financial advantage over employees doing comparable work.

How do the IR35 rules work?

Three statuses determine if and how IR35 applies:

• Inside IR35 – The contractor effectively works as an employee of the client
• Outside IR35 – Contractor works on a self-employed basis
• Partially inside IR35 – Contractor has some client employee features but is not fully caught

If engagement is inside IR35, the contractor’s PSC must deduct PAYE tax and NICs from payments to the contractor as if they were an employee. Outside IR35, normal PSC procedures apply.

For public sector engagements, the client must now determine IR35 status and handle PAYE deductions if necessary. In the private sector, it remains the PSC’s responsibility to assess status correctly.

Who decides on IR35 status?

HMRC provides an online IR35 employment status checker tool to test IR35 status. However, determining status is more complex. All the individual circumstances around working arrangements must be considered carefully.

The client decides the contractor’s IR35 status in the public sector and handles payroll taxes accordingly. Disagreements can be taken to HMRC.

In the private sector, it remains the PSC’s duty to determine IR35 status correctly. But clients and agencies often now check their status, too, to ensure compliance and reduce their own risks.

What are the tests for being inside or outside IR35?

There are three main aspects assessed to judge if someone works on an employed or self-employed basis:

Control: Does the contractor have autonomy over how, when and where they complete work? Can they send substitutes? Do they provide significant materials/assets?

Substitution: Does the contractor have an unfettered right to send a substitute in their place?

Mutuality of Obligation: Is the client obliged to offer work and the contractor obliged to accept it? Are there notice periods or penalties?

Other factors like part and parcel working arrangements, financial risk, and parties’ intentions are also considered holistically. It can be a grey area. Many engagements fall somewhere between fully employed and fully self-employed.

Even if engagements are outside IR35, PAYE and NICs may still be due on salary payments from the PSC to the contractor. IR35 does not override other employment taxes. It specifically affects how the remaining income after salary is taxed – via dividends or PAYE.

What does it mean if caught by IR35?

If classed as inside IR35, the fee-payer must deduct income tax and NICs from what would otherwise be paid as dividends before paying the PSC.

The client handles PAYE on deemed salary payments in the public sector and pays Employers NI. In the private sector, the PSC must correctly account for PAYE/NICs, including Employer’s NI.

Being inside IR35 eliminates much of the tax benefits of using a PSC over employment. However, limited company expenses and corporation tax deductions still apply. Contractors inside IR35 can be financially impacted but still benefit from other advantages of a PSC, like flexibility and limited liability status.

IR35 is complex legislation. Contractors should take expert tax advice on their status, options, and obligations. Though sometimes viewed negatively, IR35 aims to ensure fair and equal tax treatment for all. If you need help regarding tax resolution or compliance, please contact Tax Accountant at 0800 135 7323 or email info@taxaccountant.co.uk for expert advice.