What is IR35? Am I inside or outside? Help!
We’ve put our IR35 guide together out of pure and simple need. The first question many new and/or potential clients fire at us, before we’re even properly acquainted, is:
“Help, I’m inside IR35! How do I get out?”
As such, our guide hopes to help you achieve three things:
- to understand what IR35 is in plain English;
- to determine whether you’re inside (ouch!) or out;
- take practical steps to remain compliant, thus outside of IR35.
The fact that you’re inside IR35 may well be the reason you’ve landed here today. Just realise, it’s not the be all and end all of your business. But if the tax man is already investigating the nature of your business, do make sure you get in your accountant’s good books ;).
Two things you must do whilst under investigation by HMRC
Whilst under investigation, there are two things you absolutely should do. First and foremost, carry on working! Even if you’re inside (IR35, not prison), that doesn’t mean the end of all tax benefits. But be prepared: they will be greatly reduced.
The second thing you should consider is contacting Qdos Contractor.
Qdos are leading experts in IR35 matters and have supported UK contractors and freelancers for over a decade. They specialise in IR35 compliance and business protection and have done since IR35’s inception.
As such, Qdos have built an entire suite of products and services to tackle this legislation. It’s all aimed at achieving compliance and protecting any potential IR35 liability.
From the beginning: what is IR35?
The government introduced IR35 in 2000 as part of HMRC. Its original purpose was to investigate the self-employed who were gaming the UK’s tax system.
Contractors were the main target of “intermediaries legislation”, to give it its working title. More specifically, those who were, for all intents and purposes, an employee.
The type of person IR35 were (and are) pursuing would works the same hours at the same jobs as others directly employed by their client.
The differentiating factor was that the contractor either operated through their own limited company or an intermediary. The latter could have been an agency or umbrella company designed to accommodate this type of contracting.
Even though we now understand what HMRC introduced IR35 for, there’s still a huge grey area. It’s the industry’s firm belief that 6 in every 10 contractors operate in a state of limbo. That is, should HMRC investigate them, the outcome could go either way.
The problem is that many contractors don’t know their predicament. 20% of contractors know that they’re “definitely contracting”. An equivalent 20% know that they’re not. That’s one helluva grey area between.
Does IR35 affect me?
The Revenue builds up a forensic picture of all parties involved in an investigation. Their focus is on inter-connecting relationships, often the biggest tell-tale sign of ‘being inside’.
This includes the existing contractor/client relationship and, in many instances, any pre-existing relationship.
It’s the pre-existing relationships that are key, here. Especially if you’ve worked as an employee for your client before going solo. Here’s why:
One of the catalysts that led to the creation of intermediaries legislation was that an employee would:
- sit down with their boss;
- negotiate a way to undertake their existing role but as a self-employed entity;
- quit their “employed” status to take on the same role, but invoice through an agency or their own limited company.
This scenario suited both parties as it absolved the employer of any commitment to pay NICs or work out the employee’s PAYE tax. In return, contractors could offset much more against their annual tax bill.
What no one figured was the government’s resolve to quash this practice. In the eyes of HMRC, this is not contracting; this is becoming a disguised employee.
Using dynamic pieces to build a picture
A history between two parties will not be the only factor HMRC considers. The way a contractor conducts their business beyond their main client activity is another big factor.
Rather than judge each piece of “evidence” on its own merit, IR35 teams paint the whole picture before reaching a verdict.
Each factor present weights on the overall scenario, but in unequal measure. The degree attached to each is perhaps more pertinent than any single factor just being present.
Let’s ask you one question:
If you swapped your current contract for a full time contract with your client, would it influence the way you operate?
The closer to “No!” your answer, the more likely it is that you are working inside IR35.
How to prevent being caught by IR35
Even though a client hires you to provide a service, you must be able to distinguish whether you’re providing a service or a skill.
Don’t forget, you are operating as a limited company. As such, your client is engaging the company, not you as an individual.
Here’s a great acid test that you can carry out on any contractor business. If the company director/contractor cannot carry out their service in person, can they send in a substitute?
It might be easy to say, “Yes!” But just think about the consequences for a second.
Your company is, all the while, developing its brand, its reputation. Can you ensure that anyone you employ to provide a service in your company’s name won’t damage that reputation?
You’ve built the core principle of your business around your skillset. There’s much more on the line than IR35 if you expose your brand to unnecessary risk.
Other ways of proving you are a business
Another key aspect of business is marketing. It may be foreign to you. You may be working full time for the one client (there’s a hint!), so why bother?
If you’re seconded into one main role that covers your bills, marketing may not seem necessary. In fact, there’s a good chance you won’t consider networking or maintaining a website worthwhile. I’d ask you to think again.
Businesses do not rely on one client. In order to show your diversity, it’s imperative that you market your brand.
This doesn’t only make sense for proving that you’re outside of IR35, but it’s good business practice, too.
Grow your company brand
Those new to contracting are understandably budget-conscious in their first few years of trading. But even if there’s no budget to outsource marketing at the outset, you should still be networking.
Touting your business is an unnatural concept for the majority of contractors. You created your business to supply your service, not become a marketing guru, after all.
Yet finding one or two smaller projects to run alongside your main one will prove that you’re not a one-trick pony. That’s without mentioning the extra income or new strings you can add to your bow.
How can you do this? Enter social media communities on LinkedIn and Google+. Search for business forums around your niche and contribute. Ask questions if you can’t provide answers. Get involved.
For some, this is a tough ask. But it breaks the monotony of work, work, work, a typical cycle those new to self-employment can find themselves in.
This type of engagement may also help you discover industry sector pain points that you were unaware of. By connecting with peers and sharing experiences, you’ll pick up workarounds for uncommon problems.
And go to trade shows and present your business cards to potential suppliers and customers. Get your face known in your industry.
“But my client likes me to be there 9-5!”
I hear you. And that brings us onto the next point…
You are the captain of your own ship, no one else
Clients! Can’t live with ‘em, can’t live without ‘em. However, when it comes to your business, you call the shots.
We’re not suggesting that you start dictating to your clients. That’s a surefire way of running your business into the ground. You won’t need HMRC to pull the rug from beneath you.
However, do take complete control of your business’ destiny. Again, it announces your intent, that you’re serious. And it’s another degree of separation that will help you to prove that you’re a business, not a disguised employee.
Work to your own schedule, within limits
You and your client will agree the service you’re going to provide to them through your limited company. If you’re working on site, times are set by the client’s hours.
But if you’re working from home, maybe through an agency, the only working time criteria should be the completion date. This is particularly pertinent to freelancers who work from one ad hoc project to the next.
If it’s a big project, tackle it in stages. Create milestones along the way, points to discuss progress and problems. Your client may even want to re-focus the project’s direction.
If they ask for something beyond your skillset, don’t just turn the offer down. This is a great opportunity to outsource part of job.
By bringing in another specialist, it will help convince IR35 teams that you are indeed a business. Offering services beyond your remit can also help establish you as a go-to authority in your niche.
Business is all about solving someone’s problems. The fewer people a client needs to go to, the greater value they’ll place on your service.
Whatever time you spend working on that project – office or trading hours notwithstanding – should be down to you.
Logging your own hours for invoicing purposes is one way of demonstrating a degree of independence.
The only entity you’re exclusive to is your business
The more you can prove that you’re not exclusive, the greater your chance of establishing that you’re outside IR35. Furthermore, a client should not expect you to be solely at their disposal if they’ve hired you on a temporary contract basis.
It will help your cause if you’re working on two or three paid projects at any given time. For different paymasters, of course.
These could be JVs or ad hoc freelance agency assignments. You don’t even have to do those in your working week. Tackle secondary projects at the weekend if your main engagement looks similar to a routine 9-5 schedule.
Undertaking your own industry learning is also another great way of showing HMRC that you’re in business to grow. Client mentoring can be welcome, but be careful. That could give the wrong impressions about your relationship.
If there is a learning curve involved in accepting a contract, have your client deduct a minimal amount for “training”.
Yes, it’s an expense, but tiny compared to HMRC adjudging you as receiving in-house training.
Obligation and Provision of Equipment
When the instruments and tools you need to carry out your service are on site and/or provided by the client, it can muddy the waters.
Provision of equipment is always an issue if you’re working on client-sensitive information. But your client won’t risk their contract just to satisfy your IR35 requirement.
They’ll be more concerned about the Data Protection Act, if the type of work falls under its jurisdiction.
In such instances, ask your client to provide a clause in your contract. Have them underline that no contractor-side tools are acceptable. It will look even better if you can ask the client to charge you a small fee for the hire of their equipment to help you carry out your service.
Do whatever you can to show that all work must be undertaken on site using a client’s equipment in order to carry out your contract. If you can, it’s doubtful that HMRC will try to use this against you in establishing a closer than usual proximity to your client.
The tax man will look for instances that suggest you’re becoming “part and parcel” of a client’s business. In that respect, if you’re offered any of the following, you must politely refuse:
- invitations to company events and subsidised meals;
- expense or gift cards;
- security cards (unless specified as “contractor”);
- designated parking and/or company car;
- paid leave (holiday or sickness);
- off-site training grouped in with employees;
- pension contributions or bonuses funded from the company’s coffers.
Each may be tempting, but don’t risk them. They’ll only go to prove a relationship beyond your contract.
Pay, conditions and liabilities
Finally – and most obvious – HMRC will check out exactly how you’re paid.
Payment for a set amount of work, rather than on a day-, hour- or weekly rate, takes some getting used to. Especially if you’ve recently made the step up from permanent employment.
However, HMRC does count regular payments in its review. If your pay frequency mirrors that of permanently employed colleagues, it will count against you.
If you’re engaged in a long-term project, break it down into achievable milestones. Each milestone should represent a pay-point as well as a deliverable on your part.
Your client should confirm this in your contract, alongside confirmation of your (non-)relationship. Both are extra work, but no one said going alone was going to be easy!
Operate like a business and you’ll be unstoppable
Ultimately, these measures aren’t meant to only benefit you from a tax inspection standpoint. They’ll help free you from the “on-the-clock” mentality.
In doing so, they also demonstrate good business practice. And that’s no coincidence.
Working towards production targets rather than clock-watching should boost your productivity and earning potential. Any restrictions on time are now as flexible as a Salvador Dali painting.
Also, there’s no obligation to hang around once you’ve reached a milestone. Raise the invoice and move onto the next stage or next client if you have to wait for feedback.
And finally, remember that HMRC is looking to prove that you’re an individual entity, not a business. The best form of defence here is attack:
- surround yourself with your professional indemnity and liability insurances;
- register for VAT if your turnover warrants;
- invest in (necessary) computers and bespoke tools of the trade;
- create your Internet Real Estate (websites, blogs, social media profiles, etc.);
- order branded company stationary;
- prove your intent: act like a business!
And do hire a contractor-friendly accountant to prepare your books to a professional standard.
Yes, accountants are an expense that makes those new to contracting wince. But you’ll learn that a good accountant always saves you much more than they cost.
And one last question: have you ever heard of a business without an accounts department? No, neither has IR35.
Author: John Yerou
John Yerou is the owner and founder of Freelancer Financials; a trading style & trade mark of the award winning Mortgage Quest Ltd. One of the most recognised names in providing mortgages for contractors and freelancers across the UK.
In 2004 John began his career in Financial Services as an independent mortgage adviser and broker. John has been instrumental in negotiating bespoke underwriting for contractors with high street lenders.
His presence in the industry as a go-to expert is growing by the day and he is regularly cited and writes in publications both locally and nationally.