How Is IR35 Status Determined?
August 2nd, 2023
We have already discussed what IR35 is and how it can affect businesses and individuals alike. We have also explained what constitutes employment and what can determine if a contractor falls inside or outside IR35. Now, it is time to discuss the criteria the HMRC uses to determine an individual’s IR35 status.
IR35, also known as off-payroll working rules, is important to make sure people working as freelancers or independently pay the same income tax and National Insurance contributions as an employee would.
Since navigating tax laws and regulations can be challenging, businesses and individuals wondering what their IR35 status is and how it can impact their activities should always seek legal advice.
In this article, we will discuss how the HMRC determines if individuals fall inside or outside IR35 and how you can stay compliant with the regulations.
Who falls inside IR35?
According to the HMRC, the IR35 rules can affect workers who provide services through an intermediary company, clients who receive these services, and agencies or suppliers involved in the process of providing services.
There are different rules that apply depending if the worker is providing services for a small business or a larger company. However, you are unlikely to fall inside IR35 if you are employed by an umbrella company.
What is an umbrella company?
An umbrella company is an intermediary that provides employment services to contractors. It acts as an employer for people providing services independently, working on assignments for various clients.
When a contractor works through an umbrella company, they become an employee of that company, which handles administrative tasks.
Under IR35 regulations, umbrella companies are responsible for ensuring compliance with employment laws, including the payment of statutory employment rights and benefits, such as holiday pay and sick pay to the contractor.
Who determines the employment status of a worker?
According to the HMRC, the entity responsible for determining the employment status of a worker is usually the client company. However, it is important to note that work relationships might differ, and this responsibility might fall under someone else.
There is a tool available to help determine the employment status of an individual. This tool can be used by companies or individuals directly hiring a worker, agencies or workers themselves.
Determining the employment status of a worker means it is clearer what are the taxes obligations of everyone involved and if IR35 rules apply or not.
What is considered when assessing an employment status?
There is not one single factor that will determine if a worker is considered employed by an organisation. For this reason, using the Check Employment Status for Tax (CEST) tool provided by the HMRC can be extremely helpful.
However, here are some characteristics you should consider when determining if you or your contractor can be considered employed:
To determine employment status, the person responsible or the HMRC, might examine the level of control exercised by both the contractor and the client over the work being performed.
If the client has significant control over how, when, and where the work is carried out, it suggests there is an employment relationship.
Another aspect of the work that might suggest an employment relationship is if the contractor is obligated to personally perform the work, not having the option to provide a substitute.
Mutuality of obligation
HMRC looks at whether there is an ongoing obligation for the client to offer work and for the contractor to accept it. If there is a consistent expectation of work and acceptance, it suggests an employment relationship.
Contractors who bear the financial risk of the work, such as liability for correcting mistakes or costs associated with project delays, are more likely to fall outside of IR35.
HMRC considers the degree of integration of the contractor within the client’s organisation. If the contractor is treated as an integral part of the client’s workforce, it indicates an employment relationship.
How to be compliant with IR35
Once the employment status and the relationship between workers and companies are clear, it is important to ensure compliance with IR35. Both contractors and clients need to understand and adhere to regulations.
Contractors are the individuals who provide a service to the client company. Here are some of the factors to consider to ensure compliance with IR35:
1. Review your contracts
Carefully examine your contracts and working arrangements to determine if you fall inside or outside of IR35. Consider factors such as control, substitution, mutuality of obligation, financial risk, and integration. Seek professional advice if needed.
2. Provide a detailed service
Clearly demonstrate that you are providing a genuine service as a self-employed contractor rather than an employee. Document the nature of your work, specific deliverables, and the level of autonomy you have.
3. Maintain financial independence
Show that you are taking financial risk and have a genuine opportunity to profit or incur losses. Avoid receiving employee-like benefits or allowances from the client.
4. Use a contract review service
Consider using a professional contract review service or an employment specialist to assess your contracts and working practices. They can provide guidance on compliance and make recommendations for any necessary adjustments.
5. Implement business-like practices
Conduct your contracting activities in a business-like manner. Maintain separate business accounts, professional insurance, and marketing materials to emphasise your independent status.
Clients are the companies that receive the services provided by contractors. Here’s what these companies should have in mind to ensure IR35 compliance:
1. Assess employment status
Use HMRC’s guidelines and tools, such as the Check Employment Status for Tax (CEST) tool, to evaluate the employment status of contractors. Conduct a thorough review of the working arrangements, ensuring compliance with IR35 regulations.
2. Provide reasoned determinations
Make determinations for each contractor’s engagement and clearly communicate the assessment to the contractor. Provide reasons for the determination, outlining how it aligns with IR35 rules.
3. Engage contractors directly
Establish a direct contractual relationship with contractors instead of using intermediaries, such as personal services companies. This ensures that the responsibilities of the client are clearly defined and that the employment relationship is appropriately structured.
4. Train hiring managers
Educate your hiring managers and other relevant personnel about IR35 regulations, their implications, and how to assess the employment status of contractors. This helps ensure consistent compliance across the organisation.
5. Seek professional advice
If you have complex contractor engagements or are uncertain about the application of IR35, consult with tax or legal professionals who specialise in employment status and IR35 compliance.
Remember that compliance with IR35 is an ongoing process. Regularly review contracts and working arrangements, stay informed about changes to the legislation, and consult with professionals to ensure continued compliance with IR35 regulations.
Determining employment status under IR35 and ensuring compliance with these regulations is crucial for both contractors and clients in the UK. The employment status has significant implications for tax obligations and employment rights, making it essential to correctly assess whether a contractor falls inside or outside of IR35.
As we mentioned, it can be difficult to navigate through the complexities of tax laws. The HMRC offers tools, such as the CEST tool, that can help businesses and workers to determine their status and understand work relationships better. However, it is important to also consider other factors, as we listed above.