What is IR35 and what are the key factors that HMRC look at with regards to IR35
IR35 is UK tax legislation designed to combat tax avoidance by workers supplying services to clients via an intermediary, such as a personal service company (PSC), who would otherwise be classified as employees if the intermediary was not used. The rules ensure such workers pay similar income tax and National Insurance contributions (NICs) as regular employees.
Key Factors HMRC Looks At for IR35
HMRC assesses IR35 status based on employment tests, including:
- Control – Does the client control what, how, when, and where the contractor works? More control suggests employment.
- Substitution – Can the contractor send a substitute to do the work? A genuine right of substitution suggests self-employment.
- Mutuality of Obligation (MOO) – Is the client obliged to provide work, and is the worker obliged to accept it? If so, this suggests employment.
- Financial Risk – Does the contractor bear financial risk, such as rectifying errors at their own expense? Financial risk suggests self-employment.
- Provision of Equipment – Does the contractor use their own equipment rather than the client’s? Using their own equipment suggests self-employment.
- Integration – Is the contractor treated like an employee (e.g., included in staff meetings, given company benefits)? Greater integration suggests employment.
How HMRC Determines IR35 Status
CEST Tool (Check Employment Status for Tax): A government tool used to assess IR35 status, though it has been criticized for being unreliable in complex cases.
Contract Review: HMRC examines the written contract and working practices to see if they reflect an employer-employee relationship.
Investigations: HMRC can open inquiries into past tax years and issue backdated tax demands, interest, and penalties if they believe a contractor has been misclassified.
Protecting Clients as Accountants
To help clients avoid falling foul of IR35:
Ensure Proper Contracts – Draft contracts reflecting genuine self-employment, including substitution clauses and reduced client control. You would always want to get a legal eye to look over the contracts.
Work Practices Alignment – Ensure actual working arrangements match the contract (e.g., contractors should not have set hours or be treated as employees).
Use IR35 Insurance – Encourage clients to obtain tax investigation insurance to cover legal costs in case of an HMRC inquiry.
Regular Reviews – Conduct periodic IR35 status reviews, especially when renewing contracts or starting new engagements.