IR35 Off-Payroll Working

The off-payroll working rules (commonly known as IR35) are designed to ensure that individuals who work through their own limited company but would otherwise be considered employees pay broadly the same tax and NIC as if they were directly employed. The rules have been significantly reformed, with responsibility for determining employment status shifting from the contractor to the engager for medium and large organisations.

How IR35 Works

IR35 applies when a contractor provides their services through an intermediary (typically a limited company or personal service company) to a client. If the relationship between the contractor and the client has the characteristics of employment — control, substitution, mutuality of obligation, and other employment indicators — then the engagements within the contract are deemed employment for tax purposes. The intermediary must then account for tax and NIC on the deemed employment income rather than paying the contractor through dividends or salary at a lower rate.

Medium and Large Company Responsibility

From April 2021, responsibility for determining IR35 status was extended to medium and large companies in the private sector (public sector organisations have been responsible since 2017). The engager (client) must issue a Status Determination Statement (SDS) to the contractor and the fee payer, setting out whether the engagement is inside or outside IR35. If the engager fails to take reasonable care in making the determination, HMRC can transfer responsibility for the tax to the engager rather than the intermediary.

CEST Tool

HMRC provides the Check Employment Status for Tax (CEST) tool online to help engagers and contractors determine whether IR35 applies. CEST asks a series of questions about the working arrangement including control, substitution, financial risk, and mutuality of obligation. The tool provides a binding opinion provided the answers given are accurate. However, CEST has been criticised for producing inconsistent results in some cases, and many engagers supplement it with independent legal advice.

Deemed Payment Calculation

When a contract is determined to be inside IR35, the intermediary must calculate the deemed employment payment. The calculation takes the total payments received from the client, deducts allowable expenses (which are now very limited — most home office and travel expenses are no longer allowable), and deducts the contractor's salary. The resulting amount is treated as employment income, subject to PAYE Income Tax and employee NIC. The intermediary must also pay employer NIC (at 13.8% on the deemed payment) and may need to account for the Apprenticeship Levy.

Penalties for Non-Compliance

HMRC can charge penalties where IR35 is incorrectly determined or where deemed payments are not correctly calculated and reported. The maximum penalty for deliberate non-compliance can be up to 100% of the tax under-declared. Interest is also charged on late payments. Engagers that fail to take reasonable care in making status determinations can face penalties and HMRC can transfer the liability for unpaid tax and NIC from the intermediary to the engager.

Appeal Process

Contractors and intermediaries can challenge HMRC's IR35 determinations through the normal tax appeals process. This begins with a review by HMRC, followed by an appeal to the First-tier Tribunal (Tax Chamber). The tribunal has dealt with a number of significant IR35 cases in recent years, and case law continues to evolve. Many contractors take out IR35 insurance to cover the cost of defending against HMRC challenges.