Inside or Outside IR35? Crack HMRC’s Rules with This Checklist

Over the past few years, IR35 has been a hot topic. The private sector underwent a major change in April 2021. Medium and large-sized businesses, not contractors, now determine IR35 status. This has created extra complexity. Recruitment agencies face this challenge more acutely, as they could receive hefty tax bills when end clients make wrong IR35 decisions. Non-compliance can get pricey too. Contractors found to be ‘inside IR35’ must pay income tax, National Insurance Contributions, and possibly pension contributions.

This detailed IR35 checklist explains what these rules mean. You’ll learn about inside IR35 status and get practical tips to make accurate determinations. This article will also help you handle HMRC’s requirements confidently, whether you’re a contractor worried about your status or a business working with freelancers.

Understanding IR35: What It Means to Be Inside or Outside

HMRC created IR35 rules in 2000 to catch “disguised employees” – contractors who work like employees but pay less tax through their own limited companies. These regulations make sure people working through intermediaries (usually Personal Service Companies) pay the right tax when their work setup looks like employment.

What are IR35 rules?

IR35 targets the tax difference between employment and self-employment. People also call it the “intermediaries legislation” or “off-payroll working rules.” The rules make workers who run their own companies pay Income Tax and National Insurance Contributions just like regular employees when their work looks like employment.

The government created these rules because some contractors avoided higher tax rates while basically working as employees. Now tax treatment depends on how you actually work rather than your contract structure.

Inside IR35 meaning vs outside IR35

HMRC sees you as an employee for tax if you’re “inside IR35,” even though you work through your limited company. This means:

• You pay tax like PAYE employees
• Your Income Tax and National Insurance come out at source
• You can’t claim many business expenses
• You’ll take home less money compared to outside IR35 status

The rules treat contractors “outside IR35” as truly self-employed. This status lets you:

• Pay yourself through salary and dividends
• Claim legitimate business expenses
• Handle your own tax matters
• Keep more of what you earn through better tax planning

Your classification can affect your finances by a considerable amount, so getting it right matters.

Who is responsible for IR35 determination?

Contractors used to decide their own IR35 status. Recent changes have shifted this responsibility:

• Public sector clients make the call (since April 2017)
• Medium and large private sector businesses must decide contractor status (since April 2021)

Small businesses don’t need to follow these changes. Contractors still decide their own IR35 status when working with them. A small business needs two of these features:

• Annual turnover under £10.2 million
• Balance sheet total under £5.1 million
• 50 or fewer employees on average during the tax year

Clients must give contractors a formal Status Determination Statement (SDS) that explains their decision. They also need a process that lets contractors challenge decisions they don’t agree with.

The IR35 Checklist: 8 Key Tests to Determine Status

Tax case law sets out several tests that determine your IR35 status. HMRC uses these tests to check if you’re a genuine independent contractor or more like an employee. Here are eight factors that shape IR35 determination:

1. Control: Who decides how the work is done?

The amount of authority your client has over your work methods matters. Employment-like relationships emerge when clients dictate what, when, where and how you complete tasks. Real contractors keep control of their work processes and don’t let clients tie them “hand and foot.” Your employment status becomes questionable if there’s too much oversight or if clients can move you between different tasks.

2. Substitution: Can someone else do the work?

You show signs of self-employment if you have a real right to send a qualified replacement. This proves you’re not providing personal service – a clear sign of employment. HMRC won’t accept just having a substitution clause without practical use. Your contract needs an unrestricted substitution clause that lets you send another qualified person to do the work.

3. Mutuality of Obligation (MoO)

MoO looks at whether your client must offer work and you must take it. Employees typically expect ongoing work. Your projects should have clear end dates without any obligation to continue working afterward. Employment status becomes more likely with open-ended or auto-extending contracts.

4. Financial Risk: Who bears the cost of mistakes?

Unlike employees, self-employed contractors take on financial risks. These risks involve fixing poor work at your expense, investing in training, getting business insurance, and possibly losing money on fixed-price projects. Taking financial risks shows you’re truly running your own business.

5. Equipment: Who provides the tools?

Using your own essential equipment points to self-employment. IT contracts often require using client equipment for security, but providing your own fundamental tools shows business independence. This factor’s importance grows with how vital the equipment is to your work.

6. Part and Parcel: Are you integrated into the business?

Your level of integration in the client’s organisation matters. Signs of employment include appearing in company directories, showing up on org charts, managing employees, or using company email addresses. You should keep clear boundaries between yourself and the client’s permanent staff.

7. Right of Dismissal: Can the client end the contract easily?

Employees usually get notice periods. Contractor arrangements should allow quick termination. Short notice periods (under 30 days) or ending contracts for convenience suggest contractor status. Reasonable notice periods can still work in your favour.

8. Employee Benefits: Are you treated like staff?

Getting typical employee perks points to employment status. These include holiday pay, sick leave, pension contributions, staff discounts, or access to subsidised facilities. Real contractors shouldn’t expect or receive such benefits.

How to Align Contracts and Working Practises

Lining up your contracts with actual working practises is the life-blood of a strong outside IR35 determination. Your paperwork should reflect genuine business relationships rather than serve as window dressing.

Avoiding employee-like clauses

Strong contracts eliminate language that suggests employment. Terms that imply supervision or control over your work methods should be removed. Clear liability clauses that require appropriate professional indemnity insurance and responsibility to fix defective work at your expense should be included. Definitive project end dates or deliverables help avoid open-ended engagements.

Using project-based milestones

Project-based contracts have much firmer ground outside IR35 than time-based arrangements. Many advisors call project structuring critical to show independence. Work should break down into outcome-based milestones with clear deliverables rather than day-rate payments. This approach naturally removes mutuality of obligation both within and between contracts.

Clarifying substitution rights in writing

Substitution clauses must work in practise, not just exist as contractual provisions. Your company should have language that specifies its ability to provide any suitably qualified personnel to deliver services. You must document that you’ll bear all costs to provide a substitute. Note that restrictions about skills or security clearance don’t invalidate substitution rights.

Documenting independence in daily work

Daily work practises need evidence beyond contractual terms to show independent status. Maintain records of:

• Work completed outside original scope
• Defects rectified at your expense
• Potential substitutes database
• Client communications confirming working arrangements

Tools and Support for IR35 Compliance

Tools exist to support your IR35 compliance strategy that help contractors and businesses manage determination risks better.

Using HMRC’s CEST tool

HMRC’s Check Employment Status for Tax (CEST) tool shows the tax authority’s view on employment status based on your answers to questions. HMRC stands by CEST results. The tool doesn’t reach a conclusion about 20% of the time. CEST’s determination helps you validate reasonable care as long as your information stays accurate.

Using IR35 Shield or Qdos

You should look at other assessment tools if CEST says it’s “unable to determine” your status. IR35 Shield and Qdos give you expert-led assessments instead of algorithm-based decisions. These services guarantee clear outcomes every time, unlike CEST. They also include insurance protection for “outside IR35” determinations.

Getting a professional contract review

Professional reviews spot problematic clauses that could trigger IR35 concerns. At WCL we can review both contract terms and working practises and suggest changes to improve your position.

Conclusion

IR35 regulations create challenges for contractors and businesses alike. You need to really understand the rules to protect your interests.

HMRC’s CEST tool helps assess your status, but it has its limits. Tools like IR35 Shield and Qdos give better results. It’s important to have professional contract reviews, which is something we can help you with.

Wrong classifications can lead to heavy tax bills and penalties for everyone involved. If you’re unsure of your setup, please get in touch. Taking action now will protect your finances and keep you compliant with HMRC’s rules, whether you’re a concerned contractor or a business working with freelancers.