What is IR35? Understanding the rules

Introduced in 2021 for the private sector, and in 2017 for the public sector, off-payroll working rules (IR35) force employers to take up the responsibility for determining if contractors are acting as suppliers or employees.

Documented as one of the most dramatic payroll legislative changes the UK has ever seen, IR35's introduction wasn’t smooth sailing, facing multiple delays, discussions and backlash.

In this blog, we've unpacked the complicated history of IR35 and documented everything businesses need to know when tackling the legislation.

What is IR35?

IR35 (also known as off-payroll working regulations) strives to improve the tax process between an employer and their contractor.

According to HMRC, IR35 ensures contractors who would otherwise be considered employees when offering their services directly to the employer pay National Insurance and are taxed to the equivalent of a regular employee.

So, under IR35, businesses that use contractors from a personal service company (PSC), or other similar arrangements, must determine whether those workers are suppliers or employees.

As an employer, once you make your decision, you must:

• Inform the party you are engaging with (agency or umbrella company) and the worker of your decision, determining whether the rules apply, their status and your reasoning
• If a labour supply chain is involved, your decision must be cascaded down each part of the chain

Help: use the Government tool here to determine if a worker is a contractor or employee.

Inside and outside IR35

If a worker is deemed to be working as self-employed, this is known as “outside of IR35”.

As such, it's their responsibility to ensure all personal and company taxes are paid accordingly and on time. 

If the contractor is being treated as a full-time employee/is receiving the same benefits or the service reflects that of employment, then it is deemed as “inside IR35”; for example, a contractor working at your office full-time who is expected to pick up a range of jobs rather than one specific project. 

IR35 for the public sector

Since 2017, those in the public sector, such as schools, universities, local authorities and Government departments, have had to abide by IR35.

As such, they have had the responsibility of deciding if the off-payroll working rules should apply when contract workers provide a service. 

IR35 for the private sector

On the 6th of April 2021, IR35 was rolled out across the private sector, placing the responsibility on businesses to set the IR35 status of all contractors.

Why was IR35 Introduced

IR35 has been introduced to try and resolve issues regarding tax non-compliance.

Historically, contractors were responsible for determining if they were acting as an employee.

HMRC estimates that less than 10% of personal service companies complied; it’s thought the annual tax cost of this non-compliance could have been as much as £1.3bn.

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How is IR35 regulated?

To assess IR35, HMRC uses a ‘test of employment’ in line with UK employment law.

Rather than looking at written contracts between workers and businesses, HMRC reviews the ‘true nature’ of these working relationships.

The results are presented to a judge who then provides a final verdict on whether IR35 applies.

Three considerations when assessing a worker's employment status

When evaluating a contractor's relationship to establish if they fall “inside IR35”, consider these three areas:

Right of substitution

Can the contractor provide an alternative contractor to perform the services outlined in the contract?

Mutuality of obligations (MOO)

This indicator states that an employment relationship exists only when there is a commitment from a business to offer work and from the individual to execute the work.

Control

Examine whether a contractor is genuinely independent in the context of a contract; factors that suggest independent work habits include the option of when and how the contractor works, signalling a situation where IR35 does not apply.

History of IR35

As mentioned above, IR35 came into play within the public sector in 2017 and within the private sector in 2021.

However, IR35’s introduction was far from smooth sailing.

The legislation saw multiple delays and was even at risk of being scrapped at one point.

Initially, IR35 for the private sector was due to come into play in April 2020; however, the Chief Secretary to the Treasury, Steve Barclay, announced that it was to be postponed a year because of the disruption caused by the COVID-19 pandemic.

Then in September 2022, the Chancellor, Kwasi Kwarteng, announced that off-payroll working reforms are being scrapped.

The Chancellor said: “We can also simplify the IR35 rules – and we will. In practice, reforms to off-payroll working have added unnecessary complexity and cost for many businesses. We will repeal the 2017 and 2021 reforms.”

Kwarteng’s desire to repeal IR35 was swiftly retracted the following month once Jeremey Hunt became the new Chancellor.

Why did IR35 face backlash?

IR35 faced severe backlash, with campaigns such as Stop The Off-Payroll Tax arising to try stop the change.

With the reforms toughening HMRC’s stance on off-payroll working eligibility and placing responsibility on businesses, many were unhappy.

Ultimately, the resistance boiled down to more paperwork and potential tax penalties if they got it wrong.

Does IR35 apply to me?

As defined by the Government, off-payroll working applies to the following groups:

• Those who provide their services to clients via an intermediary, typically their own limited company or personal services company
• Clients (the person receiving the service) who receive services from a worker through their intermediary
• Agencies, or other suppliers, offering workers’ services through their intermediary

Note: different rules apply to those working for small businesses and those working for mid or large-sized businesses.

How does IR35 impact recruitment?

With IR35 in mind, businesses need clear processes in place for regularly reviewing staff, contractors and employment contracts.

Consider the following:

1. Clearly state whether new roles are for self-employed contractors or permanent employees
2. Ask the agencies you work with about their capacity to implement PAYE if a contract falls within IR35
3. Record the IR35 status of new recruits to ensure a compliant process
4. Communicate the terms of engagement during the offer and onboarding process. Clear documentation and procedures are crucial to understanding the financial implications of an IR35 status
5. Keep track of the IR35 status of each vacancy and ensure reports are updated regularly

Offloading the burden

With IR35 placing the responsibility on employers, it can at times feel overwhelming, especially for those lacking internal payroll resource.

If this is the case for your business, we advise you to look into payroll outsourcing to help offload the burden.

For those interested, check out our award-winning payroll outsourcing service, IRIS Fully Managed Payroll.

Learn more about IRIS Fully Managed Payroll

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