Inside IR35 vs Outside IR35

In this blog, we’ll talk in more detail about changes to the rules which impacted who defines the status of an engagement. It’s important for all parties in the supply chain to know what this means, especially contractors working and operating via their own Personal Service Companies (PSCs) providing services across all industry sectors.

What is IR35?

IR35 was introduced back in 2000 as a way for HMRC to crack down on the issue of ‘disguised employees’. Also referred to as the ‘intermediaries legislation’ or ‘off-payroll’ rules, IR35 is there to make sure off-payroll and on-payroll workers are taxed fairly. It is designed to ensure that those operating as contractors are genuinely self-employed.

What is the aim of IR35?

In HMRC’s view, too many workers offering services through a their own PSC working as a contractor and receiving the advantages that come with it, such as lower tax and national insurance, were actually working the same as an employee.

So HMRC introduced IR35 as a way to determine the employment status of who was ‘inside’ or ‘outside’.  HMRC wanted to crack down on those taking advantage of the benefits associated with being self employed. So now, if a contractor is identified as an employee for tax purposes, they need to pay Income Tax and NICs equivalent to that of a permanent employee.

How has IR35 evolved?

IR35 has been around for over two decades, it experienced big changes in 2017 and 2021. The main change was that responsibility for determining IR35 status would now rest with the end client, rather than the contractor, as it had been since inception. There are exceptions to this which we’ll discuss later in this blog, and provide details on the public and private sector reforms.

Inside IR35: A closer look

What does it mean to be inside IR35?

If an inside IR35 determination is found, the worker is classed as an employee for tax purposes. They’ll pay the same Income Tax and NICs as if they were an employee.

What are the implications of being found inside IR35?

There’s an obvious financial implication for a contractor being inside IR35: as they’ll pay the same amount of tax an employee would, which reduces their take-home pay compared to an outside IR35 determination.

Whilst one particular engagement may be inside IR35, a contractor may have multiple contracts at any one time, and each of these would need to have an IR35 determination. So although one assignment may be less tax efficient, others may not, and they can still receive the related tax benefits.

Outside IR35: A closer look

What does it mean to be outside IR35?

‘Outside IR35’ means the engagement has been deemed a genuine business to business relationship or contractor genuinely self-employed. As a result, they can fully reap the rewards of self-employment, and remain responsible for paying their own taxes like Income Tax and National Insurance Contributions.

What are the implications of being found outside IR35?

Contractors will take home more than they would inside IR35. In addition, as is often consistent with working genuinely self-employed, they will likely have more flexibility in their working arrangements, for instance more flexible hours and control over their work.

Determining IR35 status

Navigating IR35 legislation is challenging for contractors. There’s no straightforward way to determine whether an assignment is inside or outside, which makes it critical to follow careful steps when approaching a new contract. We’ve provided the following guide to help you understand how the process works:

1. Know what you need to do

As a contractor, your role in determining your engagement’s IR35 status could be fairly minimal, as this responsibility may lie with the end client. Ask the client or recruitment agency for confirmation, they have an obligation to tell you which rules apply.

2. Understand the rules

If your assignment is through either the public sector or a medium-to-large private sector business, the responsibility lies with the end client. If you’re working for a small business or your end client has no UK connection or permanent establishment, you can expect to remain responsible for determining the status of the contract yourself, but both of these instances should be confirmed by your client.

3. Assess accurately

Should you need to assess the engagement, you must do so against key factors. These include Personal Service, Control, and Mutuality of Obligation (MOO). Guidance for some contractors can be extremely complex, so it’s recommended you seek specialist help. When you do, ensure you know the details around the services you’ll be providing to the end client, plus when and where you’ll execute this.

The importance of accurate determination

How you work is key to determining your engagement’s status, so it’s a good idea to check your contracts accurately reflect your working practices. These should also be checked by a professional service.

This is important because the status must be as accurate as possible, then if HMRC decides to investigate, there’s minimal chance of it being incorrect. Inaccurate statuses can result in paying not just owed tax, but interest and penalties; the bill could be crippling in terms of financial risk.

What tools are there for assessment?

HMRC has developed their own tool: CEST (Check Employment Status For Tax). It’s not compulsory to use, and many contractors and other parties in the supply chain are opting not to. It’s led to inaccurate determinations, as it doesn’t test for a crucial aspect: MOO. Plus, we’ve found it doesn’t come to a conclusion on whether an engagement is inside or outside IR35 for 22% of occurrences. There are many other tools you can use, including our own IR35 Status Tool.

Where contractors are responsible for determining status, a contract review should be the first step towards checking an engagements IR35 status.

Secondly, your working practices should also be checked to ensure the contract matches the working reality. Our IR35 status review asks between 29–34 yes/no questions to establish a rounded view on your contract and working practices. These questions have been carefully curated, giving you a valid determination and comprehensive report. Any borderline cases are passed to our in-house IR35 experts for a manual review, providing further assurance.

Risks and mistakes – and how to avoid them

What are the common misconceptions around IR35?

There are many misconceptions, namely as a result of the reforms. Because the changes impacted who was mostly responsible for determining IR35 status, some contractors now believe they’ll never have to do this themselves. But this isn’t the case. If the end client is classed as small, rather than medium or large, then you would still be responsible, likewise the clients location matters too. If they’re overseas, the responsibility would still rest with you.

Another misconception is that if you use your own equipment then your assignment can’t possibly be inside IR35 and therefore you can’t be classed as an employee for tax purposes. However, the status determinations depends on much more than tools – there are other factors at play.

What are the possible penalties for inaccurate determinations?

Penalties can be extremely high. If you’re liable for the IR35 determination and it’s inaccurate, you’ll need to pay the difference in tax, and any interest. Plus, you may be penalised up to 100% of the taxable amount, which is judged on whether it’s perceived that you took reasonable care and steps in your determination. Ultimately, if proper procedures aren’t followed, you could face a huge bill totalling tens of thousands of pounds.

What are best practices for contractors?

The first best practice we recommend is that every time you start a new contract or assignment, get the IR35 status assessed. This applies to both private and public sector contractors. Even if it’s the same end client, or they change your working practices, the status should be reassessed. These can affect it, and therefore risk a wrong inside or outside IR35 determination.

We also suggest speaking to the client or recruitment agency prior to determining status. As a contractor, you can’t be certain what rules apply to your engagement, and the client or recruiter is obliged to tell you which IR35 rules impact you. We strongly recommend you seek specialist advice.

Our final best practice is to have your contract reviewed, and a working practice review carried out – this will look broadly at how you work day to day. Ensure the two mirror each other, so your determination will be as bulletproof as possible.

Recent changes and their implications

What’s the timeline of significant IR35 changes?

The first big changes to IR35 occurred in 2017, and specifically only applied to the public sector. This changed who determined IR35 status to be end clients.

Part of this was that any relevant party would need to be given a Status Determination Statement (SDS), for example a recruitment agency or contractor. End clients would have to demonstrate that ‘reasonable care’ was taken when defining status. There’s also a fee-payer in this instance, and it’s generally the recruiter – they must deduct the Income Tax and NICs at source.

These reforms in the public sector were extended to the private sector in 2021. Though, as already discussed, this has exceptions. If the end client is a small business or overseas, the rules may not apply, which impacts private sector contractors as it means they’ll need to determine their assignment’s status.

Don’t deal with IR35 alone

The importance of understanding IR35

It’s incredibly important that you understand the legislation, the difference between inside and outside IR35, and all the reforms. This way, you can be certain who the determination rests with, and what action to take. Not being in the know risks an inaccurate determination and potentially a penalty. The financial risks are far too high.

Stay informed on IR35 through Kingsbridge

To ensure you have a good understanding of IR35, you should stay up to date, especially as the legislation has been known to change quickly in recent years.

Our blog is regularly updated so you can be fully informed. And if you’re ever unsure, you can seek professional advice from our experts. Simply get in touch with our friendly team.