First issued in 2000, IR35 targets those workers considered in the eyes of HMRC to be ‘disguised employees’. Contractors, being technically self-employed, are not taxed in the same way as average employees, taking dividends from their company and paying far less in National Insurance Contributions. Because of this, HMRC are keen to ensure that those working as contractors (and paying less tax) are indeed genuinely in business on their own account, and are not working in the same way they would have been if employed directly by their client.
In an enquiry, HMRC will look at the contract you have with your agency (or end client if direct), so this is the first thing to check when determining your IR35 status. Some contracts will contain negative clauses from an IR35 perspective, so it’s important to have it reviewed as early as possible.
They will also delve into the actual relationship between you and your client, commonly referred to as your actual working practices. If your contract is IR35 compliant but they subsequently find that you are treated like an employee in reality, they will effectively say the written contract is worthless. It is therefore vital to ensure that your contract and working practices mirror each other.
There are a range of IR35 status tests which are used to paint a picture of employment or self-employment. In general, they look to determine whether you are operating like a genuine business providing a contract for services, or akin to an employee providing a contract of service. Using the status tests, the hypothetical contract is built - this is the hypothetical agreement between you as the worker and the end client organisation you provide services to, to determine the taxes to pay.
If you are operating ‘outside’ IR35 and take dividends from your company, you run the risk of being on the receiving end of an IR35 enquiry. This is effectively an investigation where HMRC review your circumstances and ultimately decide whether or not you have been paying tax correctly.
If they decide that you are a ‘disguised employee’, you will be required to make a deemed payment, effectively paying back all tax and NI you would have paid if you were an employee (plus interest and a possible penalty). This can easily run into tens of thousands of pounds, which is why IR35 is such a big issue for contractors.