What should you factor into an IR35 compliance test?

For twenty years, contractors determined their own employment status under the off-payroll working rules (IR35). Although the factors used to determine status have not changed, responsibility for status assessments has passed to you, the employer, along with the financial risk.

This is one in a series of articles for HR, finance and procurement leaders in the public and private sectors. In this article, we cover:

Who should determine IR35 status
When you have to run an IR35 compliance test
Factors to consider when determining status under IR35
How to ensure compliance once work has started
How to create a compliant contract for your off-payroll workers
Take control of IR35 from choosing a contractor to making your final payment to them

For more information on IR35 compliance for employers, please call CoComply on +44 (0) 203 051 9792, email [email protected] or fill out the form below.

Who is responsible for ensuring compliance?

The organisation or company you represent is responsible for determining whether contractors are truly self-employed workers if you own or work for a:

Public sector body
Private sector company with an average annual turnover of £10.2m or less over the past two consecutive financial years

IR35 self-determination still applies when contractors provide services to smaller companies.

When do you have to run an IR35 compliance test?

IR35 compliance tests determine whether an off-payroll worker is:

An independent provider of services
A “disguised” or “deemed employee” in HMRC’s eyes

Off-payroll workers, most commonly referred to as contractors, invoice you for their services. These independent providers of services often set up their own limited company (sometimes referred to as a personal services company) to receive payment from you. They (and your organisation) pay a lot less in tax with this arrangement.

HMRC knows this and they want to put a stop to it.

So, in 1999, they first announced IR35, an employment status test to determine whether the true nature of the relationship you have with a contract is a “customer-supplier” relationship or an “employer-employee” relationship.

Self-employed or disguised employee?

When there is a “customer-supplier” relationship, this is classed as self-employment and is outside IR35. In this arrangement, the contractor is responsible for paying tax. You do not deduct any tax from their invoices.

An independent contractor’s services are not covered by employment law. You do not have to and should not offer them sick pay, holiday pay or any type of paid leave.

When there is an “employer-employee” relationship, this is inside IR35.

Contractors inside IR35 are not considered self-employed workers. Instead, they are classified as workers for tax purposes. You are legally obliged to collect and transfer income tax and National Insurance based upon the value of their invoice. You also pay employer National Insurance contributions unless they are employed by an umbrella company in which case they pay it.

Which factors determine IR35 status?

IR35 is complicated piece of employment legislation. To make things more difficult, you need to understand the 20 years of case law that backs it up. That case law is often contradictory.

We’re going to assume that you want to offer an “outside IR35” arrangement to your off-payroll workers in this article.

To arrive at an outside IR35 status that you can successfully defend in the event of an HMRC investigation, the structure of your working arrangement with your contractor should be as follows:

Substitutability. You should not stop your contractor from sending in other people to complete the work specified in your contract.
Level of control. Senior staff within your business should not exercise managerial control over contractors nor should you ask contractors to manage your employees. You should not dictate, other than as specified in the contract, when, how and where a contractor or their substitute provides their services.
Office holders. A contractor should not fill a permanent role or position currently or previously held by someone else in the business.
Financial risks. Contractors should meet the cost of any mistakes from their own funds. They should have a minimum of public liability and professional indemnity insurance.
Obligation. You must not oblige contractors to carry out work on your behalf nor can they oblige you to provide work to them.
Right of dismissal. Any notice period stipulated in a contract should be reasonable.
Integration with the host. You should not provide contractors with benefits or privileges associated with employees like business cards, parking spaces, gym use or bonuses. Contractors should not be subject to disciplinary action or performance reviews.
Exclusivity. You should allow contractors to work for more than one client at a given time.

Working practices are important – they’re more important than the contract covering your engagement. Your contractor’s independence should be baked into the written contract and you should reflect their independence by interfering with what they do as little as possible.

Consider each contractual arrangement independently and always do your due diligence. Don’t download IR35 contract templates or issue blanket or role-dependent status determination statements. Neither option generally ends well.

Also, try to avoid using HMRC’s Check Employment Status for Tax (CEST) tax tool. The tool is buggy, is unable to determine IR35 status in 20% of cases, and HMRC won’t stand by the results it gives if they launch an investigation into your IR35 processes and practices.

Ongoing compliance after initial IR35 compliance tests

Your IR35 compliance test with each contractor never ends. The more you take your eye off it as time passes by, the greater the tax risk you face.

An end client like your business or organisation should constantly review contractors’ working conditions to make sure they mirror closely what you agreed to in your contract.

Good IR35 housekeeping is retaining copies of all invoices and correspondence related to individual contractors including third-party status reviews and your Confirmations of Arrangements.

IR35 control from status determination statement to final payment

The financial implications for getting IR35 compliance wrong are steep. But you cost yourself the opportunity to work with great talent if you take the safe option of declaring all contractors inside IR35.

CoComply offers another safe option. We manage compliance month by month from before a contract goes live beyond the final payment to your contractor.

We not only reduce the costs of doing business for you and your contractors. We provide your company or organisation with the competitive edge needed to attract the most talented contractors to work for you. For more information, please get in touch.