IR35 is a piece of UK tax legislation designed to identify whether a contractor is genuinely self-employed or is effectively working as an employee, but through an intermediary such as a limited company. Determining IR35 status is crucial for both contractors and businesses, as it affects tax liabilities and employment rights.
Read our article below, created in collaboration with Markel Tax, to understand the factors that influence how IR35 Status is decided under the IR35 off-payroll working rules – Chapter 10 Part 2 ITEPA 2003.
Who is responsible for determining IR35 status?
The end-client is responsible for deciding a contractor’s IR35 status. To understand more about when the decision of this responsibility was updated, read our article here.
Key factors which influence determining an IR35 status
IR35 status is determined by assessing a range of factors which are essential for contractors and businesses to consider carefully to ensure compliance and avoid potential tax liabilities.
The question to start with is: “Do we have a contract of employment?”
This question is considered as, in the landmark employment status case Ready Mixed Concrete v Minister of Pensions and National insurance (1968), Justice MacKenna set down factors that were consistent with a contract of employment, and answering this question would confirm that if one or more of these factors was missing, a contract of service (employment) could not exist.
The three key elements which need to be present for a contract of service to exist are:
- Personal service
- Control
- Mutuality of obligation
Therefore, if any of the above 3 are missing, the contract cannot be a contract of service and is more indicative of a contract for services (self-employment).
The three key elements are explained in detail below, in addition to other key factors which are considered when deciding a contractor’s IR35 status:
Personal service
If an individual is required to provide the services personally and cannot send a substitute, this is typically an indicator of a contract of service (employment). If a substitute can be sent to perform the work, it cannot be a contract of service and must therefore be self-employment.
However, the right to send a substitute should be absolute and not overly fettered to be effective in demonstrating a lack of personal service; i.e. the client or agency should only be able to refuse a substitute on certain grounds.
A contract should contain:
- A clear right for the Personal Service Company (PSC) to provide, not ‘offer’, a substitute.
- The client’s grounds for refusal should be limited to a lack of skills, experience, and qualification (and perhaps security clearance) and no more.
- The PSC remains in the contractual chain and responsible for the engagement and payment of the substitute.
- The PSC remains responsible for any handover costs – but there should be no requirement for a handover to last for a specific period (that is the PSC’s decision).
Control
A client retaining a right of control over the worker is indicative of a contract of employment. If it can be shown that the client does not have the right to exercise control over the worker, case law dictates that you cannot be an employee.
The most important element of control is whether the work provider controls the way the worker performs the services, i.e. ‘how’ the services are performed. Many engagements are projects which the client has determined must be undertaken and, for practical reasons, can only be undertaken on site and within office hours. However, that is the same for the employee as it is for the independent contractor. What determines whether the contractor is free from client control is whether the contractor is responsible for how the work is done.
Contracts must have a clause which is unambiguous, as a clause which only offers ‘reasonable autonomy’ is not good enough to deny the client (or agency) a right of control.
Mutuality of obligation
There are two areas to be considered under mutuality of obligations:
- Is there an obligation for one party to offer work, and if offered, is there an obligation for the other to accept (often referred to as ongoing mutuality)?
- Is there mutuality within the engagement, i.e. is there an expectation that the engagement must be seen through to the end by the contractor/service provider?
To fully satisfy the requirement for a lack of mutuality of obligations, it should be clear that a lack of obligations exists with regards to both the ongoing work and during the contract period.
HMRC’s current opinion is that the provision of services in exchange for payment is sufficient to create mutual obligations between the parties. However, a lack of mutual obligations is potentially the hardest area on which to base an argument than an engagement should fall outside IR35.
Financial risk
The level of financial risk taken by the contractor is key in deciding whether a contractor is a part of the client’s company. Contractors who are genuinely in business on their own account often bear financial risks, such as providing their own insurance, correcting mistakes at their own cost, and facing the possibility of making a loss. Employees, by contrast, usually receive a guaranteed wage or salary, irrespective of the company’s performance. Evidence of financial risk, such as investment in the business or exposure to commercial risk, supports an outside IR35 status.
Employee benefits
Receiving employee benefits, such as paid holidays, sick pay, pension contributions, or bonuses, is a significant indicator of employment – contractors who are genuinely self-employed should not receive these benefits. The provision of such benefits may indicate that the contractor is, in fact, working as an employee, and therefore falling inside IR35.
Equipment
The ownership and provision of equipment used to carry out contract work can be an IR35 indicator as genuine contractors typically use their own equipment, tools, and resources. However, if a contractor relies on the client’s equipment, it may suggest an employment relationship, as employees generally use tools and resources provided by their employer.
Intention of parties
Both parties should clearly document the nature of the relationship, with contracts reflecting self-employment terms. However, tribunals and HMRC will look beyond the contract to assess the reality of the engagement. If the working practices align more closely with employment, IR35 may apply regardless of the written agreement.
Tools to help support an IR35 status decision
Several tools are available to support an IR35 decision and help clarify employment status.
CEST: HMRC’s Check Employment Status for Tax (CEST) tool asks a series of questions about the working relationship and provides an indication of whether a contract falls inside or outside IR35. The accuracy of CEST depends on the information provided, and it also may not cover every scenario.
IR35 review from an expert: Tax experts or specialist advisers offer tailored analysis of contracts and working practices, often providing more of an in-depth insight than automated tools – especially helpful in complex cases.
Role-based IR35 assessments: These assessments focus on the specific duties and level of autonomy associated with a role rather than solely the contract terms. This method considers how the role is performed on a day-to-day basis, helping to highlight potential risks.
FAQs
Does my IR35 status affect my ability to claim expenses?
Typically, if you are inside IR35, you can claim on a limited range of expenses, such as certain pension contributions and business-related travel. If you are outside IR35, you have more freedom to claim a broader range of business expenses, including equipment, travel, and subsistence costs.
Does my IR35 status affect my pension contributions?
Your IR35 status can influence how pension contributions are made. If you are operating inside IR35, pension contributions must be paid out of post-tax income, as your income is treated as employment income for tax purposes. If you are outside IR35, you can make employer pension contributions directly from your company before tax, which can be tax efficient and reduce your overall corporation tax liability.
How often should I have an IR35 status assessment?
Regularly review your IR35 status, especially before the start of each new contract or whenever there is a significant change to your working arrangements. This ensures you are complying with HMRC regulations and helps to avoid potential tax liabilities.
Discover our knowledge centre for more help and guidance, or read more about Caunce O’Hara’s contractor insurance.
Please note: This article provides guidance for information purposes only. It should not be relied upon wholly when making or taking important business decisions – always seek the services of an appropriately qualified professional. The views expressed by websites referenced to are limited to those of the websites, and do not necessarily reflect the views of Caunce O’Hara. Caunce O’Hara is not affiliated with any of the brands, companies or websites mentioned in this article.
