IR35 (Intermediaries Legislation) is a set of tax rules in the UK that determines the tax status of individuals who work through an intermediary, such as a limited company, or recruitment agency for a client.
When engaging an interim limited company contractor, there are several IR35 risks and considerations to be aware of.
Status Determination
One of the main risks is that HM Revenue and Customs (HMRC) may determine that the contractor is a “disguised employee” rather than a genuine independent self-employed contractor. This could result in the contractor being classified as inside IR35, which means they should be treated as an employee for tax purposes.
Under IR35 legislation in the UK, whether a worker is considered employed or self-employed mainly depends on these factors:
Control: If the client or employer tells the worker exactly what to do, when to do it, and how to do it, the worker is more likely to be considered employed. Self-employed individuals typically have more control over their work.
Substitution: If the worker can send someone else to do the job in their place, they are more likely to be self-employed. Employees usually can’t do this.
Mutuality of Obligation: If there’s an ongoing expectation for the client to provide work and for the worker to accept it, it leans toward employment. Self-employed individuals typically work on specific projects with no long-term commitment.
Financial Risk: If the worker takes financial risks, like investing in their tools or equipment, they are more likely to be self-employed. Employees generally don’t take these risks.
Integration: If the worker is fully integrated into the client’s company, working alongside employees and following company rules, they might be seen as an employee.
HMRC provides an online tool called the Check Employment Status for Tax (CEST) tool. It’s designed to help determine a worker’s employment status for tax purposes.
While not mandatory, it can provide guidance and is widely used. The HMRC CEST report provides a quick initial assessment of the status of a contractor but should not be relied upon in isolation.
Given the complexity of IR35 rules, it’s advisable to consult with a legal or tax professional with expertise in employment tax law. They can provide guidance specific to your situation.
Who is responsible for Tax Liability?
If a contractor is deemed to be inside IR35, the responsibility for deducting and paying taxes and National Insurance contributions falls on the end-client, not the contractor’s limited company. This can lead to unexpected tax liabilities for the client. If they are engaged through an intermediary such as a recruitment agency, the responsibility falls to the intermediary. HMRC may still have recourse to the end client if taxes are not paid or the end client was the cause of the deemed employment relationship.
Backdated Tax
If an IR35 determination is made retrospectively for a previous engagement, the client may be liable for backdated taxes, including income tax and National Insurance contributions, as well as interest and penalties.
Financial Impact
The financial impact of IR35 can be significant. Clients may need to account for employer’s National Insurance contributions, holiday pay, and other employment-related costs for contractors inside IR35, which can increase the overall cost of engaging contractors.
Contractual Risk
The terms of the contract with the contractor’s limited company are crucial in determining IR35 status. If the contract is found to be a sham, or if the working relationship differs substantially from the terms of the contract, it can lead to an inside IR35 determination. Examine the written contract between the worker and the client, but also consider the actual working practices. Sometimes, the contract may not accurately reflect how the relationship actually operates.
Assessment Responsibility
As of April 2021 (in the private sector) the responsibility for determining IR35 status shifted from the contractor’s limited company to the end-client or intermediary (e.g. an agency). This places the onus on the client to make accurate determinations and conduct thorough assessments.
Penalties and Interest
Failing to comply with IR35 rules can result in penalties and interest charges from HMRC. These financial penalties can be substantial and add to the overall cost of non-compliance.
Reputation Risk
Clients found to be non-compliant with IR35 rules may face reputational damage, which can impact their relationships with contractors, customers, and partners.
