IR35 explained: how to tell if your contract is inside or outside

What is IR35?

IR35 is a UK tax legislation designed to prevent "disguised employment". This occurs when a worker provides services to a client through their own limited company or other intermediary, but their working relationship is effectively that of an employee. The rules aim to ensure fairness in tax contributions between genuinely self-employed contractors and those who are, in practice, employees.

If a contract is deemed "inside IR35", it means the working arrangement is considered employment for tax purposes. This typically results in higher Income Tax and National Insurance Contributions (NICs) being deducted, similar to a PAYE employee. If a contract is "outside IR35", it means the worker is genuinely self-employed, allowing them to operate more tax-efficiently through their limited company, paying Corporation Tax and drawing income as a mix of salary and dividends.

Who is Responsible for the Determination?

The responsibility for determining whether a contract falls inside or outside IR35 depends on the size of the client receiving the services:

• Public Sector Clients: The client is always responsible for determining the worker's employment status.
• Medium and Large Private Sector Clients: The client is responsible for assessing the IR35 status for each engagement. They must issue a Status Determination Statement (SDS) to the worker, explaining their conclusion and the reasons behind it.
• Small Private Sector Clients: If you provide services to a small client outside the public sector, your own intermediary (e.g., your limited company) remains responsible for deciding your employment status for tax purposes.

A private sector client is considered "small" if they meet at least two of the following criteria for two consecutive financial years (figures for financial years beginning on or after 6 April 2025):

• Annual turnover of no more than £15 million
• Balance sheet total of no more than £7.5 million
• No more than 50 employees

Inside or Outside IR35: The Key Factors

HMRC looks beyond the written contract to examine the actual working practices of an engagement. Several factors are considered, with three main tests carrying significant weight:

1. Control: This assesses the degree of control the client has over what, how, when, and where you do your work.

• Outside IR35: You have significant autonomy over how you deliver the work, including your methods, hours, and location (within reasonable project constraints).
• Inside IR35: The client dictates your working methods, hours, and location, similar to an employee.

1. Substitution: This refers to your right to send a substitute to perform the work in your place if you are unable to.

• Outside IR35: Your contract explicitly allows you to send a suitably qualified substitute, and the client would accept this. This demonstrates you are providing a service, not a personal service.
• Inside IR35: You are expected to perform the work personally, with no genuine right of substitution, or the client would reject a substitute.

1. Mutuality of Obligation (MOO): This considers whether there is an obligation for the client to offer you work and an obligation for you to accept it.

• Outside IR35: There is no expectation of ongoing work once a specific project is completed, and you are not obliged to accept further work.
• Inside IR35: There's an ongoing expectation of work and acceptance, similar to an employer-employee relationship.

Other factors that HMRC may consider include:

• Financial Risk: Do you bear financial risk, such as having to correct unsatisfactory work at your own expense or having the potential to make a loss as well as a profit?
• Provision of Equipment: Do you use your own equipment, or does the client provide everything?
• Part and Parcel: Are you integrated into the client's organisation, attending staff meetings, having a staff email address, or receiving employee benefits?
• Exclusivity: Do you work for multiple clients, or is the engagement with one client effectively full-time?

Using the CEST Tool

HMRC provides an online tool called "Check Employment Status for Tax" (CEST) to help determine IR35 status.

• How it works: You answer a series of multiple-choice questions about the working arrangement.
• HMRC's stance: HMRC states it will stand by the results given by CEST, provided the information entered was accurate and the tool is used in accordance with their guidance.
• Limitations: While useful, the CEST tool has faced criticism for not always capturing the full complexity of employment status case law and sometimes resulting in an "undetermined" outcome. It's crucial to ensure the information you input accurately reflects the actual working practices, not just what's written in a contract.

Common mistakes

• Relying solely on the written contract: HMRC will always look at the actual working practices, which can override what's written in a contract.
• Not taking "reasonable care": For clients, failing to properly assess status for each engagement can lead to significant penalties. For contractors with small clients, not carefully determining your own status can also lead to issues.
• Blanket determinations: Clients making a single IR35 determination for all contractors in a role, rather than assessing each engagement individually, is not taking reasonable care.
• Ignoring working practices: Even if a contract looks "outside IR35", if daily working practices resemble employment, HMRC will likely deem it inside.
• Not keeping records: Failing to document how an IR35 status was determined can be problematic if HMRC opens an enquiry.