Understanding IR35 Status Determination for Contractors

In April 2017, the responsibility for declaring contractors’ employment status was transferred to public sector bodies. Four years later, that responsibility was extended to private sector medium and large businesses.

This is one of a series of refresher articles for HR, procurement and finance senior executives and managers who have been asked to deal with IR35 for their company or organisation.

In this article, we cover:

What IR35 is designed to determine
Why it’s better for you and your contractors to be outside IR35
The most important IR35 status determination questions
Outsourcing IR35 management

To speak to IR35 determination specialists, please call CoComply on +44 (0) 203 051 9792, email [email protected] or fill out the form below.

What’s the point of IR35?

IR35 is intended to ensure that the right amount of tax is paid on employment income.

HMRC has been concerned for a long time that there is tax avoidance on a massive scale in the UK. They believe that hundreds of thousands of employees and thousands of employers are actively and intentionally colluding with each other to make employees appear as if they are independent contractors. Why this matters to HMRC is that they get far less tax from contractors than from employees.

Under the revised off-payroll working rules, public sector bodies and medium to large businesses must declare each contractor they work with as either inside IR35 or outside IR35.

As the company or organisation that receives the benefits from your contractor’s work, you are the “end client” under IR35 rules. If you hire your contractors directly and pay their invoices, you are also the “fee payer”. If you hire contractors through a recruitment agency and they pay your contractors, they are the “fee payer”.

Most of the time, a contractor will use a limited company (sometimes called a personal service company) to bill you for their services.

Why it’s better for you and your contractors to be outside IR35

If a contractor is inside IR35, then you must deduct income tax payments, National Insurance and, if applicable, the Apprenticeship Levy from their invoice. You must pay this together with employer NICs at 15.05% of the gross invoice value once a month to HMRC using the Real Time Information system. If your contractor is provided by an umbrella company, the contractor pays the employer NICs although this will be reflected in a higher rate so you pay for it anyway.

With contractors outside IR35, it’s completely different. As with inside IR35 contractors, they send you invoices but you make no deductions for tax because they’re classed as self-employed. There is no 15.05% to pay on top of the invoice in employer NICs. Contractors outside IR35 are responsible for managing tax through their personal service companies.

CoComply note – Contractors supplied by umbrella companies are automatically inside IR35.

The most important IR35 status determination questions

Prior to your contractor starting work, you must complete a status determination statement. This statement sets out the reasons for your decision to declare them inside or outside IR35.

So, if you want your contractor to be outside IR35, what are the main factors you need to consider when drawing under the contract of work and deciding on their working arrangements?

Control

The less control you have over your contractors, the better.

Try to ensure:

Your contractor decides how they provide service to you. While a degree of consultation on process and method with a contractor is fine, especially when internal managers and staff they’re working with have a similar level of knowledge, you must ensure that they enjoy a significant degree of autonomy.
You don’t set your contractor task after task (especially if not covered in the written contracts) with the expectation that they’ll follow your instructions. This is indicative of an employer-employee relationship.
You are not prescriptive on the working hours and days a contractor must perform work at.
You do not dictate where the work has to be performed (unless there is no other realistic option than to carry it out in the places you specify).

Mutuality of obligation

Your contractor should not expect you to continue providing work for them. Likewise, you should not expect your contractor to accept work you offer them.

Be careful about using the same contractors over and over again. In these cases, HMRC may argue that there is an over-riding if unwritten single and continuing contract in operation akin to a disguised employee.

HMRC may also try to make the same argument on very long contracts with off-payroll workers.

Substitutability

Don’t expect or include in your contract that a contractor will provide personal service to you.

You need to allow your contractor to send others to do the work. Your contractor must pay the substitute, not your business. You do have a right of veto but you should only ever use it if you have concerns over security, experience or qualifications.

Make sure that you record the times your contractor sends in substitutes as this is strong evidence of the independence of your contractors.

Financial risk

If your contractor makes a mistake that costs your company money, they should pay to put the mistake right from their own funds.

In most situations, you should not pay for the tools that a contractor needs to perform the work. It’s a grey area if you already have the tools and you permit your contractor to use them.

Your contractor should have business insurance independent of your own insurance arrangements. Make sure you see the certificates for their professional indemnity insurance and public liability insurance policies before you commence work.

Office holders

Your contractor should not occupy a position which existed before your engagement with them and will continue after.

If you do, this work will almost certainly be inside IR35 although that may be arguable if they can send a substitute in to perform their contractual obligations.

Exclusivity

You must not restrict a contractor’s ability to work for other clients. Working for multiple end clients is something that an independent business would do meaning, a strong argument for demonstrating the independence of your contractor.

Be careful though. Even if your contractor works outside IR35 for other clients, they may be inside IR35 on their assignment to you.

Dismissal

Ideally, your contract should have no notice period with both parties free to leave at any time. You may wish to insert a clause allowing you to unilaterally leave the agreement if, for example, milestones are not met or the work is not performed to the required standard.

In practicality, this may be difficult depending on the importance and nature of the services being provided. If you do want a contractor to have to provide notice, try to make it as short as possible.

Signs of separation

If a contractor has their own website, business stationery, trading style, business cards, and inbound telephone number, their business is more likely to appear autonomous from yours.

Don’t provide your contractors with their own office space, parking space or name badge and don’t invite them to staff nights out.

Get a competitive edge with the new off-payroll working rules

It used to be straightforward to engage contractors. They were responsible for determining their own employment status. If they got it wrong, they got the fines, not you. Now it’s all changed.

But contractors still want to work outside IR35. It’s now up to businesses and organisations like yours to make sure that they make it happen by providing the contractual terms and the working conditions. As well as helping you attract the best contractors, you also save money.

CoComply helps companies create a friendly, welcome, outside IR35 atmosphere for their contractors. We take care of everything from the start and make sure you and your contractor stay on track for the duration of the assignment.

Please contact us at your earliest convenience for more information.