IR35: What even is it?

IR35 is a term you’ll see often in the world of contracting, but what exactly is it?

Once upon a time, there was an employee* who liked his job. He heard contractors can not only get paid more but can also save on tax by being paid through a company. So he quit his job and created an LTD. Then he went back to his former employer and said “I’d like my old job back please, but this time, I want you to pay me through my limited company”.

They hired his company, and he went back to doing his same old job, along with his old colleagues. But this time, no longer an employee, he could save more on tax by deciding how he paid himself through his own company.

This is a type of tax avoidance.

HMRC enters the chat.

IR35 refers to legislation that was introduced to prevent the above. HMRC realised they were loosing out on tax income because people were creating limited companies just to make them intermediaries between themselves and their employers.

Their stance is that if you behave like an employee, then you should be taxed like an employee, whether you’re working through your own limited company or not.

And if you’re not behaving like an employee, and appear to be doing legitimate business-to-business work, then IR35 won’t apply to you.

Inside IR35

So when you’re looking for a contract, and you see that it’s Inside IR35, this means that the contract is deemed to fall within IR35. Therefore, your income will be taxed at source as PAYE before it gets to you, the same as an employee.

You also will not typically be working through your own company, nor will you be employed by the client. You’ll be working through what’s known as an Umbrella company.

An Umbrella company is a company used by recruitment agencies to pay contractors. As far as HMRC is concerned, you’ll be an employee of the Umbrella company. You can use this Umbrella company for this contract, and other Inside IR35 contracts in the future.

Outside IR35

When a contract is Outside IR35, this means that what’s expected of you does not match the behavior of an employee. These contracts will require you to have your own limited company, as well as everything that comes along with it. This includes a business bank account, business insurance, and ideally an accountant.

You will be an employee of your own limited company, and your limited company will be the one in contracts with other parties. Remember, this is business-to-business work.

When the client pays, they pay your limited company in full, without any income tax being deducted. It’s then up to you to pay yourself and pay any corporation tax, income tax, and national insurance contributions you need to pay. This is where your accountants come in to help you.

What does the difference look like practically?

Something to bear in mind is whether a contract is Inside or Outside IR35 is not only about what’s in your paper contract. HMRC will care about your day-to-day behavior and working practices with the client.

For example, some (non-exhaustive) things that can determine if a contract is Outside IR35 are:

Can you choose where you work from (not constrained to the client’s office)?

Can you use your own equipment (laptop, etc) to carry out the work?

Can you carry out the work at any time (not constrained to the client’s working hours)?

Are you and the client free to decide not to continue the work at any time (no mutuality of obligation)?

Can you substitute someone else to do the work if you need to?

Do you have control over how you complete the work, without a whole lot of direction and supervision?

If the answer to most of these is yes, then it’s likely an Outside IR35 role. If most of them are no, then it’s likely an Inside IR35. These are some of the things, among others, that HMRC might look at.

Why would I pick one type over the other?

This is really your choice. But for a lot of contractors, the benefits of contracting come with Outside IR35 roles. However, Inside roles can have their perks too, such as most large multinational companies will now typically only do Inside roles for their contracts.

IR35 is sometimes referred to as off-payroll working rules and you can read more about it on the GOV.UK page.

There’s also a handy tool HMRC has created to help you check whether a contract is Inside or Outside IR35.

There are some other nuances that I’ve left out to keep this post simpler, that I will mention in the future. For example, is your contract actually with the client? How do recruitment companies factor into all this?

It also goes without saying, but none of this is financial or legal advice. It is just to give you an overview of contracting and IR35.

I’ll be posting more on IR35, amongst other contracting topics. If you have any particular questions you’d like me to answer, feel free to ping me on LinkedIn or Twitter.

*Fictional employee to illustrate IR35.