IR35 and Off-Payroll Working

A guide to IR35 and off-payroll working from the employment law experts

Marjon Law, specialist employment lawyers is owner-led by Marc Jones, who is ranked and recommended in legal publications as a leading employment law solicitor, with over 20 years of experience practising solely in employment law.

If you would like advice on IR35 and off-payroll working, please contact us.

What is IR35?

IR35 was introduced in 2000 to address concerns relating to individual contractor who supply their services via an intermediary (such as a limited company) and therefore, avoid paying income tax and National Insurance contributions (NICs), as an employee.

The off-payroll working rules apply if an individual provides their services through an intermediary to close a loophole in the tax system. The intermediary will usually be the individual’s own personal service company (PSC) where the worker would pay less tax. 

A PSC has not been clearly defined by HM Revenue and Customs (HMRC) but usually refers to limited companies with a sole or majority director/shareholder who personally provides the services of the company.

However, despite a contract being with a limited company, the reality can be more like an employer-employee relationship, where the individual should be taxed as an employee. This is referred to as a deemed employee.

The IR35 legislation looks to identify deemed employees and ensure they are taxed correctly, however, IR35 can impact those operating genuinely through a limited company structure due to the subjective nature of the legislation. The rules make sure that workers, who would have been an employee if they were providing their services directly to the client, pay broadly the same NICs as employees.

Individuals may be affected by these rules if they are:

• an individual who provides their services directly to an end-hirer client through a PSC
• an end-hirer client who receives services directly from an individual through a PSC
• an agency providing services to an end-hirer client via an individuals’ PSC.

If the rules apply, tax and NICs must be deducted from fees and paid to HMRC.

When will the rules apply?

The rules apply if an individual contractor provides services to an end-hirer client through a PSC, but would be classed as an employee of the client if they were contracted directly to the client.

The Check employment status for tax (CEST) tool provides guidance to decide if the off-payroll working rules apply.

To use the CEST you need:

• details of the contract
• details of your responsibilities
• who decides what work needs doing
• who decides when, where and how the work is done
• how you will be paid
• if the contract includes any benefits or reimbursement for expenses.

HMRC will stand by all determinations given by the CEST tool, as long as the information given remains accurate. The tool must be used again if:

• there has been a change to an existing contract or service agreement
• the information originally provided is no longer accurate.

What does ‘outside IR35’ mean?

If a contract is judged outside IR35, the individual contractor is considered self-employed for tax purposes and can pay themself in the most tax efficient way, which is typically through a mixture of salary and dividends taken from the PSC.

If the individual contractor is working outside the scope of IR35, they will responsible for making sure all personal and company taxes are calculated correctly and paid on time.

What does ‘inside IR35’ mean?

If a contract is judged inside IR35, the individual contractor is considered an employee for tax purposes and will have to pay income tax and NICs on all earnings.

Contract with the client

It is crucial to be able to demonstrate to an end-hirer client and, if required, HMRC, that a PSC is not a vehicle used to disguise employment status.

In order to limit the risk of an arrangement being judged inside IR35, contracts should include the following:

• the right to provide a substitute which is a factor in the assessment of tax and employment status. Although, one factor on its own will not typically mean you are inside IR35 or outside IR35, it is worth ensuring the PSC contract has a genuine right of substitution. (Note: the CEST tool will automatically class the individual contractor inside IR35 if there is no substitution clause in a contract)
• avoid mutuality of obligation to provide and accept work is another factor in assessing tax and employment status. It would appear from case law, that including a notice period in the contract will point towards a conclusion that there is mutuality of obligation, so this should be avoided if possible
• the PSC should be subject to as little control as possible, which is also another factor in assessing tax and employment status. If possible, the individual contractor should be free to set their own hours and place of work and to determine how the work is to be done
• contracts should, if possible, be structured by reference to completion of a project or piece of work, rather than by duration. Similarly, payment should be structured by reference to completion of a project, rather than time worked. If possible, some element of financial risk and reward (other than payment of fees) should be incorporated into the contract
• the PSC should ideally maintain insurance in respect of claims arising out of services provided by the individual contractor and this should be specified in the contract
• the individual contractor should not be integrated into the client company more than is absolutely necessary. For example, a worker should not be held out as a member of the company, should not be subject to its policies and procedures, and should not be entitled to participate in employee-type benefits
• if possible, the PSC should provide its own equipment, rather than the client providing this to individual contractor
• neither the PSC nor the individual contractor are tied to one client but are free to work for other.

All of the above points need to be weighed against the commercial requirements of the contract with the client, which will almost inevitably require an obligation of personal service. Therefore, it should be appreciated that this may bring some IR35 risk with it.

Contract between the individual and the PSC

Although less important than the contract with the client, there should be an employment contract in place between the individual and the PSC. The key consideration with the employment contract is to ensure that it is not linked too closely to one particular client.

The contract should also avoid linking the amount of salary and benefits to the client. Rather, the individual should get such salary and benefits as the PSC determines. HMRC is less likely to investigate an arrangement if the individual is paid a meaningful salary, at least roughly in line with market rates, than if income from the client is distributed primarily by way of dividends with only a very small salary paid to the individual.

The contract should also specify that a worker will be subject to the control and direction of the PSC (rather than the client to which it is providing services).

Consequences if IR35 does apply

If the contract is judged inside IR35, the sums received by the PSC are, in effect, treated as employment payments by the PSC to a worker for tax and NICs purposes and will therefore be subject to pay as you earn (PAYE) taxation. However, this is calculated at the end of the year on the deemed income, after allowing a 5% deduction to cover general expenses (unless there is supervision, direction or control, in which case PAYE must be accounted for monthly on actual payments made throughout the year).

Therefore, if IR35 applies, the relevant tax and NICs are payable by the PSC, not the client. HMRC may also charge interest and penalties to the PSC on overdue tax and NICs payments.

An individual contractor can challenge a finding by HMRC that the arrangement with the client is inside IR35 by appealing to the First-tier Tribunal. HMRC has produced guidance dealing specifically with IR35 enquiries and how to appeal against a determination.

Private sector reform

From 6 April 2021, an individual working via their own PSC, will lose the right to set their own IR35 status unless the end-hirer client is a small business in the private sector. During a 12-month period, the end-hirer client is deemed to be a small business if it meets two or more of the following criteria:

• turnover – not more than £10.2 million
• balance sheet total – not more than 5.1 million
• number of employees – no more than 50.

The responsibility for determining IR35 status transferred to the end-hirer client, with the tax liability shifting to the ‘fee-payer’ in the supply chain unless the end-hirer client is covered by the small business exemption, t PSC must determine its own R3statts.

This reform is similar to PSCs in the public sector, which came into force in 2017.

Assessing IR35

A status determination statement which outlines the end-hirer client’s IR35 status decision must be provided to both the individual contractor and the PSC. The end-hirer client must demonstrate that reasonable care has been taken when determining status. Until this is provided, then the end-hirer client will remain responsible for collecting tax and NICs.

If an individual contractor does not agree with the end-hirer client’s IR35 status decision, there is a disagreement process, which obliges the client to review a decision and provide a reasoned response within 45 days. If they fail to do this, then the client (not the PSC) will assume the IR35 liability.

Changes

From 6 April 2024, where a failure to deduct PAYE taxation is assessed, HMRC will be able to set off employer PAYE liability from the end-hirer client against taxes paid by the individual contractor and their PSC.

The changes are intended to address this problem by removing the risk of double taxation. The new regime will allow income and corporation tax paid by the PSC and contractor to be set-off against the end-hirer client’s liability to tax. These payments would previously have only been recoverable by the contractor or PSC, and the short time limits applicable to such claims often meant that HMRC was left holding more money than was ever owed.

The onus will now be on HMRC to provide relief for taxes already paid by issuing a formal direction giving notice to the end-hirer client or other deemed employer. HMRC’s power will be discretionary, so a business that has used contractors subsequently found to be caught by the IR35 rules cannot force HMRC to issue a direction.

It is important to remember, though, that HMRC, like all public bodies, has to act reasonably. So, if HMRC refused to exercise its discretion without a good reason, it would be at risk of being challenged through judicial review in the High Court. If end-hirer clients can provide information to HMRC about the taxes paid by the contractor or their PSC, this may assist HMRC in issuing a direction. 

The material contained in this web page is provided for general purposes only and does not constitute legal or other professional advice. Appropriate legal advice should be sought for specific circumstances and before action is taken.

Why choose Marjon Law for IR35 advice?

We have been advising on freelance and consultancy arrangements for over 20 years, some of which involved employment status determinations in employment tribunal claims.

As specialist employment lawyers, our clients' interests are paramount to us. 

We ensure that all our clients receive the best advice possible.

We will advise on IR35 and any subsequent determination or claim.

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