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IR35 – Intermediaries Legislation Guide

Updated: Mar 16



IR35 is a tax law introduced in 1999. It is known as the Intermediaries Legislation and came into force in April 2000 as part of the Finance Act.

Despite having been in force since 2000, IR35 is heavily criticised by tax experts and the business community as being poorly planned, badly implemented by HMRC and causing unnecessary costs and hardships for genuine small businesses.

If you are a genuine contractor, freelancer, interim or consultant who is in business on your own account, you should have nothing to fear from IR35. This is so long as you take the time to understand how the legislation works and apply best practice to ensure it does not apply to you, and have a defence prepared if investigated by HMRC.


Why was IR35 introduced by the government?

IR35 is designed to combat tax avoidance by workers providing their services to clients via an intermediary, such as a limited company, but who would be an employee if the intermediary was not used. This is where organisations engage workers on a self-employed basis and usually through an intermediary, rather than on an employment contract, so they become disguised employees.

This can save the organisation engaging the worker a significant amount of cash as they no longer have to pay employers’ NICs, and it also means they do not have to offer any employment rights or benefits such as holiday entitlements.

If such workers are caught by IR35, they have to pay income tax and National Insurance Contributions (NICs) as if they were employed. The financial impact of IR35 is significant. It can reduce the worker’s net income by up to 25%, costing the typical limited company contractor additional income tax and NICs.


Autumn Budget 2018 – New rules

In the Autumn Budget 2018, it was announced that new rules would be brought in for the off-payroll working private sector. The new rules will be brought in from April 2020.

From April 2020, the engaging business (end client) will be responsible for deciding whether the contractor/worker falls inside or outside of IR35. If the engaging business has assessed the contractor to be inside of IR35, national insurance contributions (NIC) and income tax will have to be deducted. The deductions will be made by the fee-payer.

In some cases the engaging business itself is the fee-payer, however in many cases, the engaging business is not the fee-payer as they engage a contractor through an agency who may become the fee-payer.

In such cases, the determination of employment status is still made by the engaging business and is passed down the labour supply chain to the fee-payer (agency), who is then responsible for deducting national insurance contributions (NIC) and income tax. Where a potential fee-payer has not received a determination, they would not be required to make any deductions for income tax and NICs or pay employer NICs until they have received a determination.

The fee-payer will also be responsible for sending the income tax and National Insurance Contributions (NICs) due to HMRC.

After the IR35 consultation in the beginning of 2019, the rules have changed further. The engaging business (end client) will remain responsible for determining the contractor’s employment status and if necessary, pass the determination down the supply chain. If however they are a “small company” as defined by the Companies Act 2006, the contractor will remain responsible for determining their own employment status.

The Companies Act 2006 defines a small company as one that meets at least 2 of the 3 conditions below.

· Annual Turnover of less than £10.2 million

· Balance sheet total less than £5.1 million

· Number of employees less than 50

If the engaging business meets at least 2 of these 3 conditions, the rules will not apply and the contractor will remain responsible for determining whether IR35 applies to them.


How IR35 works – the tests of employment

IR35 essentially seeks to turn a legitimate one person small business into being an employee, because of this it is underpinned by employment legislation and IR35 case law. As a result, the tests of employment used over decades by the UK legal system are applied.

Essentially, an HMRC inspector will disregard the written contract in force between the worker and their client, and use the actual nature of the working relationship to create a ‘notional contract’. An inspector, or a tribunal judge, will use this notional/hypothetical contract to determine whether the contract is one of employment, when IR35 applies, or one for business to business services where IR35 does not apply.

A common example is the ‘Friday to Monday’ occurrence. That is when an employee leaves employment with their employer on a Friday only to return to the same role in the same office on the Monday, only engaged as a contractor or consultant trading through a personal service company and paying much less tax.

Not surprisingly, determining whether you are caught by IR35 is complex. Ideally you should seek expert IR35 advice. An expert knowledge of employment law is required to fully understand and apply these tests. Neither those independent professionals being investigated nor HMRC’s tax inspectors can possibly be expected to become experts. As a result, IR35 has been incorrectly applied in numerous high profile tax cases, and contractors are left without certainty about their tax status.

Control, substitution and mutuality of obligation

In short, IR35 involves applying three principles to determine employment status.

These are known as the principal ‘tests of employment’:

Control: how much control does the client have over what, how, when and where the worker completes the work

Substitution: is personal service by the worker required, or can the worker send a substitute in their place?

Mutuality of obligation: mutuality of obligation is a concept where the employer is obliged to offer work, and the worker is obligated to acceptit.

Other factors taken into account to determine whether you are caught by IR35. These include the contract type, whether you are taking a financial risk, if you are ‘part and parcel’ of the engag

er’s organisation, being in business on your own account and provision of equipment.

All of this evidence is taken into account, and if the balance of probabilities is that the worker is an employee then IR35 applies. So, for example, if a worker has an unrestricted right to send a substitute in their place, personal service is not required and IR35 cannot possibly apply.

Control: where how, what, and when.

Contractors who are found by HMRC to be under the supervision, direction and control of their clients may also be likely to be found to be inside IR35. Control is one of the key tests of employment used by HMRC to determine whether a contractor is a disguised employee.


Both supervision and direction as described above are examples of control that are broken down into four elements:

Where: does the client have control over where the work is completed?


When: can the client dictate to the contractor specifically when the tasks must be completed?

What: this refers to the scope of the work, and works both ways. Can the client treat the contractor like an employee, allocating tasks at him? This places control in the hands of the client. Alternatively, can the contractor decide to press on when a variation occurs without seeking approval from the client? This places control in the hands of the contractor.

How: is the client providing detailed instructions to the contractor about how they should complete the work?

HMRC may only need to show than one of these four aspects of control is present, depending on the strength of the evidence, for there to be a strong case that the contractor is controlled and therefore inside IR35.

Substitutes and subcontractors

Contractors working through their own limited companies benefit twofold from using substitutes and subcontractors. Bringing on board another worker can contribute to fulfilling the requirements of a contract, particularly if the lead contractor falls ill or has to take unplanned time off.

The distinctions between substitutes and subcontractors/helpers are important in the eyes of a tax tribunal or court, because they demonstrate different aspects of how a contractor might be outside IR35 and not a disguised employee.

Right of substitution

A substitution is a powerful argument against IR35, as this implies that there is no personal service on the part of the contractor. So assuming all other evidence points towards not being a disguised employee, a contractor who has supplied a substitute will almost certainly be found outside IR35 by a tax tribunal or court.

Where there is right of substitution, i.e. when the client cannot object or does not indicate that they are expecting all the work to be done by the contractor, this is thought by many IR35 experts to be a ‘silver bullet’ against IR35.

Subcontractors who have been engaged on a basis that is natural to the completion of the contract, or where the lead contractor needs additional specialist skills to complete the project, are the most likely to be viewed by HMRC as evidence that the contractor is not a disguised employee.


Contractor guide to Mutuality of obligation and IR35

Mutuality of obligation is one of the IR35 key tests of employment used by a tax tribunal or court to establish whether a contractor is in fact a disguised employee and therefore subject to the provisions of IR35.

Put into context, mutuality of obligation is generally considered by experts to be a less strong IR35 factor compared to control and substitution, but is still seen as a significant pointer towards employment if found to apply.

What is mutuality of obligation?

There is a mutuality of obligation if the client is obliged to provide paid work and the contractor is obliged to accept and complete the work.

This situation is typical of most employer-employee relationships, in which the employee is paid by their employer each week or month and, within the bounds of job descriptions, can be asked to undertake tasks across a spectrum of activities that go outside their role. This state of affairs continues until the employee decides to take another job, or is made redundant. One worker could have a career within a single organisation that spans many job roles over many decades.

Genuine limited company contractors outside IR35 should not expect or receive such mutuality of obligation. A contractor’s limited company should be engaged on contract for services basis, to perform a specific task for a specific project, and once the project is over the contractor moves on, or may be offered a new project by the client.


Mutuality and contracts

HMRC says that there does not need to be a contract in place, or a clause in a contract that explicitly says the client must offer work and the contractor must take it. Mutuality of obligation can exist without a contract.

For example, a contractor may be working on a project specified in the contract and the client then asks the contractor to do something outside of the scope of the original contract. If the contractor completes the task, this is evidence of mutuality of obligation.

Many IR35 experts agree that case law for establishing mutuality of obligation is weak, therefore limited company contractors should ensure their contracts and working practices clearly indicate that there is no mutuality of obligation.


Employment tests in context

Mutuality of obligation is only one indicator of employment, and both case law and HMRC guidance to its own compliance officers say that there is no single simple answer to determining employment status, and therefore whether IR35 applies.

Each case is separate and will be judged on its own merits. So what may be significant in one employment status test or IR35 case may not be so important in another.

This uncertainty means that best practice is for contractors to reduce the risks of mutuality of obligation and being caught by IR35 by always having their contracts, contract amendments and contract renewals reviewed by an expert.

For more information regarding IR35, please do not hesitate to contact us or visit https://www.gov.uk/guidance/ir35-find-out-if-it-applies.

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