Do You Keep Hearing About IR35 as a Freelancer?

Are you a freelancer trying to wrap your head around IR35? Maybe you’re getting conflicting advice from different sources, or perhaps you’ve been avoiding the issue, hoping it doesn’t apply to you. Additionally, are you confident that your contracts are compliant? These are common concerns surrounding IR35 for freelancers, and this guide is here to clarify things for you! In this straightforward guide, I’ll explain IR35 for freelancers, covering what it is, how it works, and why it was introduced over 20 years ago. I’ll also help you determine if you fall "inside the rules" and are classified as a "disguised employee."

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This guide covers a lot of ground with terms, definitions, and useful links, so take your time with it. You may want to bookmark this page so you can revisit it later as you digest the information.

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Important Note:
Although I’m an accountant, I’m not an expert in IR35. The information here is aimed at a broad audience. While I strive to make these rules easier to understand, you should always consult a professional, like a contractor accountant or employment lawyer, for advice tailored to your specific situation.

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Table of Contents

1. What is IR35 for Freelancers?

2. Why Was IR35 Introduced?

3. What Do "Inside" and "Outside" IR35 Mean?

4. Off-Payroll Working

5. What Counts as a Medium or Large Business?

6. What is a Disguised Employee?

7. Are You a Disguised Employee?

8. HMRC CEST Tool

9. What is a Deemed Employment Payment and How to Calculate It

10. Does IR35 Apply to Sole Traders?

11. How to Avoid IR35

12. Contacting HMRC

 

1. What is IR35 for Freelancers?

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IR35 is legislation introduced by HMRC in 2000 to identify workers who operate through Limited Companies but are effectively employees in all but name. The aim is to ensure these individuals are taxed as employees would be, despite being paid through invoices.

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2. Why Was IR35 Introduced?

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Before IR35 was introduced, it became increasingly common for individuals to form Limited Companies—what HMRC calls "intermediary" entities—to work for employers in a way that allowed them to invoice for services rather than be paid through PAYE.

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Operating through a Limited Company can be more tax-efficient because it allows you to:

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• Deduct expenses,

• Pay corporation tax at 19%,

• Pay yourself a tax-efficient salary composed of dividends and PAYE.

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Two decades ago, running a Limited Company was even more beneficial due to a 10% tax credit on dividends, which has since been replaced by the less favorable dividend allowance. This led to a widespread formation of intermediary entities to exploit this tax loophole.

Not only did freelancers benefit from this arrangement, but employers did too. Paying a Limited Company instead of a PAYE salary saved them money on:

• Employer’s National Insurance (currently 13.8% of gross salary),

• Pension contributions (starting at 3% of gross salary),

• Holiday pay,

• Sick pay.

Additionally, freelancers had limited workers’ rights, which became appealing in the gig economy for businesses like Uber and Deliveroo.

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Those caught by IR35 must pay National Insurance and income tax on the money earned through their Limited Company as though they were on PAYE.

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Initially, it was up to the freelancer to decide if they were breaking the rules, leaving clients with little responsibility to check. However, since April 2016, the rules have evolved into what is known as "off-payroll working," where certain businesses are now responsible for determining whether a freelancer is truly self-employed or a disguised employee.

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3. What Do "Inside" and "Outside" IR35 Mean?

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Being "inside IR35" means you are considered an employee for tax purposes. If found inside, deductions will be made from payments to your Limited Company, possibly annually or through payroll under PAYE.

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If you’re "outside IR35," you can continue to freelance and invoice your client as usual without the restrictions of IR35.

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4. Off-Payroll Working

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Since its inception, IR35 has been refined to catch more people and make the rules stricter. With these changes, HMRC has started using the term "off-payroll working" more frequently. While IR35 and off-payroll working are often used interchangeably, there are subtle differences.

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In April 2017, the responsibility for determining a freelancer’s employment status shifted to public sector employers. Previously, freelancers decided their own tax status, leaving room for non-compliance. Employers could also argue that they were unaware of any disguised arrangements.

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From April 2021, this responsibility extends to medium and large private sector businesses, causing significant debate. To minimize risk, some businesses are either ending contracts with Limited Company freelancers or deducting tax and National Insurance from their payments, regardless of the invoice, by calculating a deemed employment payment.

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5. What Counts as a Medium or Large Business?

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HMRC defines medium or large private companies for IR35 purposes based on meeting two or more of the following criteria:

• Annual turnover exceeds £10.2 million,

• Balance sheet totals over £5.1 million,

• More than 50 employees.

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Businesses affected must provide freelancers with a "Status Determination Statement" (SDS), clearly outlining their decision. An inaccurate assessment can result in the business being liable for unpaid income tax and National Insurance.

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6. What is a Disguised Employee?

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Before IR35, it was common for people to leave their job on a Friday and return under a new contract through a Limited Company the following Monday, doing the same work but being paid differently. These individuals are known as "disguised employees."

A disguised employee is a freelancer who is effectively an employee but is invoicing through a Limited Company. This doesn’t only apply to full-time freelancers; even those working part-time could be classified this way.

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7. Are You a Disguised Employee?

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To determine if you’re a disguised employee, HMRC looks at three key tests in the arrangement between a freelancer and their client:

1. Mutuality of Obligation (MOO): Is the client required to provide work, and does the freelancer expect to receive it?

2. Control: Does the client dictate where and how the freelancer completes the work, rather than leaving it to the freelancer’s discretion?

3. Substitution: Can the freelancer send someone else to do the work, or would the client reject a substitute?

These aren’t the only questions HMRC considers. They also examine the broader working relationship, regardless of the contract terms, asking questions like:

• Has the freelancer paid others to help with the work?

• Can the freelancer be reassigned to other tasks without their consent?

• Does the client control the freelancer’s working hours and methods?

• Does the freelancer bear upfront costs for equipment or travel?

• Is the freelancer’s time primarily devoted to one client?

• Does the freelancer present themselves as their own boss or as part of the client’s business?

These questions aim to reveal the true nature of the relationship, irrespective of what the contract says. Even with multiple clients, you could be a disguised employee for one of them.

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8. HMRC CEST Tool

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If you’re unsure about your employment status, you can use HMRC’s online CEST tool ("Check Employment Status for Tax") to assess your situation. It asks questions about your relationship with your client and provides a likely determination. You can print the result for further reference.

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9. What is a Deemed Employment Payment and How to Calculate It?

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If you fall inside IR35, your client will deduct income tax and National Insurance from your payments, similar to PAYE. This is known as a deemed employment payment.

The client is responsible for making these deductions and reporting them to HMRC as part of their payroll obligations. You’ll then receive the net amount, similar to receiving a payslip.

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Deemed employment payments can be calculated annually or more frequently, with allowances for expenses and a 5% deduction for running costs of your Limited Company.

These deductions must be reported on a Full Payment Submission by 5 April each year, and a P60 should be issued to the freelancer for their tax return.

Even if you are impacted by deemed employment payments, you’ll still need to charge VAT on your services, as you are still providing services through your business.

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10. Does IR35 Apply to Sole Traders?

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IR35 primarily applies to Limited Companies, but it affects all workers, including sole traders. If you’re a sole trader working for a small private company, you’re responsible for determining your own employment status. However, if found to be a disguised employee, you’ll be liable for unpaid income tax and National Insurance, although your client may not be held responsible for these payments.

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11. How to Avoid IR35

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Avoiding IR35 is about staying compliant with the law—tax evasion is illegal. Remember that simply adding clauses to your contract won’t necessarily keep you outside IR35. HMRC looks at the actual working arrangement, not just the contract.

If you’re genuinely in business, IR35 shouldn’t apply because you’re not controlled by an employer. However, the nature of freelancing can make it easy to become "part of the furniture," especially if you work on-site at a client’s premises.