How to stay outside IR35: contracts and working practices

Understanding IR35: The Basics

IR35, also known as the off-payroll working rules, is UK tax legislation designed to ensure that individuals who work like employees but provide their services through an intermediary (such as a limited company) pay broadly the same Income Tax and National Insurance Contributions (NICs) as employees. The rules aim to prevent "disguised employment," where individuals gain tax advantages by operating as contractors when their working relationship is, in reality, more akin to employment.

If an engagement falls "inside IR35," it means the worker is deemed an employee for tax purposes, and Pay As You Earn (PAYE) deductions for Income Tax and NICs must be made. If it falls "outside IR35," the worker is considered genuinely self-employed, and their limited company can receive gross payments, allowing for different tax planning, such as taking dividends.

Key Factors for IR35 Status

HMRC and the courts assess IR35 status by looking at the overall picture of the working relationship, not just the contract wording. Several key factors are considered, with "control," "substitution," and "mutuality of obligation" often highlighted as the most important.

Control

Control refers to the extent to which your client dictates how, when, and where you perform your work. To be outside IR35, you should have significant autonomy over these aspects.

• What: You should be engaged for a specific project or deliverable, rather than being told what tasks to do day-to-day.
• When: You should largely determine your own working hours, provided you meet agreed deadlines. You shouldn't be required to work the same hours as permanent staff or seek approval for time off.
• Where: While some roles require on-site presence, you should ideally have flexibility over your place of work where possible.
• How: This is often the most significant factor. You should decide the methods and manner in which you complete the work, using your own expertise, rather than being supervised or directed by the client.

Substitution

A genuine right of substitution is a strong indicator of being outside IR35. This means your limited company has the right to send another suitably qualified and experienced individual to perform the services in your place, and the client must accept them.

• The right must be genuine and not "unreasonably fettered." This means the client cannot reject a substitute for reasons other than a lack of necessary skills, qualifications, experience, or security clearance.
• Your limited company should remain liable for the substitute's costs and quality of work.
• Ideally, this right should be exercisable for any reason, not just illness.

Mutuality of Obligation (MOO)

MOO refers to an ongoing expectation of work from the client and an obligation from you to accept it. In an employment relationship, there's an expectation of continuous work and payment.

• For an outside IR35 engagement, your contract should be for a specific project or deliverable, with clear start and end dates.
• There should be no obligation for the client to offer you further work once the current project is complete, nor an obligation for you to accept it.
• HMRC acknowledges that a basic level of mutual obligation exists in any contract for services (work for pay), but the key for IR35 is whether there's an ongoing obligation akin to employment.

Other Factors

While the "holy trinity" of control, substitution, and MOO are paramount, other factors also contribute to the overall picture:

• Financial Risk: As a genuine business, you should bear some financial risk. This could include correcting faulty work at your own expense, investing in your own equipment or training, or the risk of not being paid if a project overruns or is not completed to standard.
• Provision of Equipment: Generally, a self-employed contractor provides their own equipment.
• Business on Own Account: Demonstrating that you are genuinely in business, with multiple clients, business insurance, a website, and marketing efforts, can support an outside IR35 status.
• Integration: You should not be "part and parcel" of the client's organisation, attending staff meetings, receiving employee benefits (like holiday or sick pay), or being treated as an employee.

Crafting Your Contract to Stay Outside IR35

Your written contract is crucial, but HMRC will also look at your actual working practices. The contract should accurately reflect the reality of your self-employed status.

Here's what your contract should ideally include or avoid:

• Right of Substitution: Explicitly state your unfettered right to provide a substitute, with the client's agreement that they will accept a suitably qualified replacement.
• No Mutuality of Obligation: Clearly define the scope of work for a specific project or deliverable, with no obligation for future work or acceptance of it.
• Autonomy and Control: State that you are responsible for how the services are delivered, and that the client has no right of supervision, direction, or control over your methods.
• Fixed Price/Deliverable-Based Payment: Payment should ideally be for a specific outcome or project, rather than an hourly or daily rate, which can suggest employment.
• No Employee Benefits: Ensure there are no clauses relating to holiday pay, sick pay, pension contributions, or other employee benefits.
• Termination Clause: A clear termination clause that reflects a business-to-business relationship, rather than an employment notice period.
• Liability for Rectification: State that you are responsible for correcting any substandard work at your own cost and in your own time.

Working Practices: Beyond the Contract

Even a perfectly drafted contract won't protect you if your day-to-day working practices resemble employment. HMRC will always look at the reality of the situation.

• Act as a Business: Use your own business name, email address, and equipment where possible. Maintain a professional website and marketing materials.
• Manage Your Time: Work flexibly, setting your own hours to achieve project milestones, rather than adhering to the client's core hours.
• Avoid Integration: Do not become 'part and parcel' of the client's organisation. Avoid attending staff social events, using staff canteens or car parks, or being listed in internal directories as an employee.
• Demonstrate Financial Risk: If you make a mistake, rectify it at your own cost. Consider taking out professional indemnity insurance.
• Seek Multiple Clients: While not a definitive factor, having multiple clients concurrently or consecutively strengthens your position as a genuine business.
• Exercise Substitution: If the opportunity arises, genuinely offer and, if accepted, provide a substitute to demonstrate your right to do so.

Common mistakes

• Ignoring working practices: Relying solely on a well-drafted contract without ensuring your day-to-day operations align with self-employment.
• "Blanket" determinations: Clients making a single IR35 status decision for all contractors without assessing each engagement individually.
• Lack of evidence: Not keeping records to support your outside IR35 status, such as invoices, project plans, communication logs, and evidence of business expenses.
• Assuming status without review: Failing to regularly review contracts and working practices, especially when engagements extend or change.
• Unfettered vs. fettered substitution: Having a substitution clause that is so restrictive (e.g., only in case of illness, or requiring client approval without objective criteria) that it's not considered genuine.