IR35 was originally just a numbered news release in the 1999 Budget but reaction and publicity have made it a term in its own right. ‘IR35’ has courted controversy and made headlines but it has also left a lot of people mystified as to its original meaning. What is IR35?

Put simply, it was brought in to counter what the Inland Revenue (IR) saw as ‘disguised employment’. A contractual worker fills a permanent position in a company but doesn’t pay the corresponding income tax and National Insurance contributions (NIC) a permanent worker would.

The statement was basically seeking to clampdown on these so-called one-person services companies. That is, individuals who, while ostensibly acting as employees of a company, avoid PAYE by instead charging for their services under a contract.

Under the rules, a contractual worker falls under IR35 if:

  • he or she (the ‘worker’) works for a client but does not invoice the client directly for work carried out, instead:
  • the client contracts an intermediary company, which then effectively employs the worker. It is easier for the client – if dissatisfied – to dispense with the services of the intermediary than it would be if it employed the worker directly. The client also avoids PAYE or NI tax issues
  • the intermediary company, in which the worker has at least a 5% beneficiary interest, then invoices the client for the worker’s efforts
  • the worker takes their earnings in the form of a dividend (a distribution of net profits of the company to its shareholders) on which NIC aren’t paid

Hence, the IR argues, the worker is effectively employed but in tax terms is self-employed and is therefore a ‘disguised employee’.

The problem that has arisen is that contractors UK-wide are arguing the IR’s cloudy definition of the difference between self-employed and employed workers makes IR35 too arbitrary. As such they want more balanced assessments of what constitutes a ‘disguised employee’.

The reason this is important is because the IR35 regulations only apply to situations where the worker would be deemed to be an employee of the client, if it were not for the presence of the intermediary.

Guidelines exist where at first glance it would be easy to assume the contractor fell under IR35. For example, a contractor can work for a single client for good business reasons without being employed solely by them and the length of the contract in itself is not a factor in determining whether the contractor is caught in IR35.

And if you do fail IR35, the Inland Revenue is obliged to provide an explanation as to why related to your circumstances.

Where the worker is deemed an employee, all earnings of the intermediary company (which effectively becomes an employee itself) become subject to PAYE and National Insurance. In cases where companies have believed themselves outside IR35, this can mean hefty back payments.

If you think you may fall within the scope of IR35, it’s important to seek immediate professional advice from your accountant. Official guidance can be found on the IR website.