IR35 Explained — why it matters to independent contractors, freelancers and workers

IR35 Explained — why it matters to independent contractors, freelancers and workers

IR35, also known as "intermediaries legislation" is a tax law issued by HMRC. It is designed to stop independent contractors from taking unfair advantage of favourable taxation by providing services through a limited company or some other means.

If you’re an independent contractor or freelancer, it's vital to understand the implications of IR35 so you can report and pay taxes properly and don’t suffer penalties from HMRC. In this guide we’ll break down what IR35 is, let you know if it might impact you, and what you can do as a result.

Who does IR35 have an impact on?

There are two main types of workers who may be affected by IR35, they are:

  • Independent contractors — self-employed people providing services through a limited company or other, similar business.
  • Freelancers — similar to independent contractors, freelancers provide a variety of services on an "as needed" basis.

It doesn't matter what sector or industry you are in, if you’re an independent contractor or freelancer, you may be affected. This applies across every type of job role, skill set, expertise, and profession.

Who does not need to worry about IR35?

IR35 will not impact you if you fall into the following areas:

  • You’re a permanent employee of a business, receiving salary and payroll compensation, and making National Insurance (NI) and tax payments as normal.
  • You’re a temporary employee providing services directly to a business or via a staffing agency.
  • You are not considered to be under IR35 by HMRC (learn how to work out if you might be impacted below).

Why does IR35 exist?

IR35 is designed to combat tax avoidance by certain types of independent contractors and freelancers. By providing services through a limited company or similar business, invoicing a client, and then paying themselves, both the contractor and the client can avoid, reduce, or limit certain tax payments and NI contributions.

These payments would have to be made by a permanent or temporary worker, and the business employing them. HMRC wants to ensure appropriate treatment of independent contractors and freelancers, hence the IR35 rule. Independent contractors and freelancers illegally avoid these tax and NI payments as follows:

  • They provide services to a business and invoice that business for services rendered.
  • Pay themselves a minimal "salary" from their own business.
  • Take the rest of the payment as "dividends" from their business.

By doing this, they avoid some of the tax and NI payments that would normally be due if the whole amount were taken as salary.

What type of independent contractor and freelancer does IR35 impact?

Essentially, IR35 will only impact a contractor or freelancer if they would otherwise be treated as an employee by business(es) they are working for. These are known as "Disguised Employees" by HMRC and they use the limited company they own mainly as a way to avoid paying higher taxes. If the contractor would normally be a full-time or part-time employee with an employment contract, and they instead use a limited company to provide services, they are very likely to be affected by IR35.

How to work out if you might be impacted by IR35

There are no "hard and fast" rules on whether an independent contractor or freelancer will be affected by IR35 or not. Instead, HMRC assesses each case on its own merits, and uses "Tests of Employment" to decide if a contractor would fall under IR35 requirements. Review the following table to see if it’s possible HMRC would consider you as falling under IR35.

Area Possible IR35 if… Not likely to be IR35 if…
Do you generally have control over what, how, when, and where you complete work? No, my client does. Yes, I can decide.
Do you have to complete the work yourself, or can someone work in your place? I have to complete the work myself as a “personal service.” Someone else can work in my place.
Is your client obliged to offer you work, and are you obliged to complete it? Yes, my client offers me regular work that I am obliged to do. No, there is no expectation or obligation of work.
Are you taking a financial risk by doing or not doing the work? No, there is no financial risk. Yes, there is a financial risk.
Are you an essential part of your client’s organization? Yes, I am “part and parcel” of the organization. No, they could work without me.
Does your client provide the equipment you work on? Yes, they provide the equipment. No, I use my own equipment.
Do you receive benefits like sick pay, holidays, or bonuses? Yes. No.

An HMRC inspector will ask these and similar questions and use the balance of answers to decide if you would be affected by IR35. This will not be affected by how many contracts you have, the length of the contract, or any of the stated terms and conditions in the contract. HMRC inspectors can declare such contracts to be a "sham" and will decide on IR35 status independently of them. Instead, they will base their decision on your actual working relationship with your client.

There are a variety of free IR35 testing tools available online to help you decide if you would be impacted by IR35. However, we strongly recommend chatting to your accountant and/or lawyer if you are unsure.

What is the impact of being found liable under IR35?

If you are found liable under IR35, the main impact is that you will need to pay more tax. The amount will vary depending on your unique circumstances. HMRC will demand the difference in taxes and NI from you, including penalties and interest. HMRC can also go back up to six years and demand these payments retrospectively.

What can I do if I am affected by IR35?

Unfortunately, not very much. If you believe you will be caught under IR35, you should get onto a standard employment contract with your client as soon as possible. You should also speak with your accountant to understand what your tax and NI penalties are likely to be. Finally, you should get your finances in order so you are able to pay the tax, NI, interest, and penalties that HMRC will demand. HMRC may agree to a payment plan, but this is only decided on a case-by-case basis.

In all cases, we strongly recommend you speak with your accountant or a tax lawyer as soon as possible so you can understand what your liabilities are likely to be. They will be able to give you personalized advice to help you reduce the impact as much as possible.

Further Reading

Spring Statement 2022: What it means for small businesses

How to manage the final hospitality VAT rate increase in AccountsPortal

Ten Purchases You Didn't Know Were Tax-deductible