IR35: What’s the story with Britain’s ‘most hated tax’?

Off-payroll working is governed by rules known as IR35, which dictate whether or not workers who provide their services to an employer via an intermediary pay tax and national insurance like an employee or are treated as self-employed.

The rules apply to workers who would be employees if they provided their services directly to the company rather than via an intermediary.

It is a complex area of tax and employment law; however, tax disputes between celebrities such as Gary Lineker and HMRC have put it in the public eye.

IR35 is unpopular with contractors, many of whom feel they have been wrongly classified to their detriment or subjected to blanket policies that do not properly take into account their individual positions. So much so that in 2023 the Telegraph described IR35 as one of HMRC’s ‘most hated tax traps’.

However, the taxman has listened to complaints and in April 2024 introduced IR35 offsets, which allowed taxes already paid by contractors and their intermediaries to be set off against any liability owed by their employer. This made the system fairer and more balanced, as well as more predictable.

In addition in September 2024, the Supreme Court clarified the tests for employment status, which made it easier for companies to pass HMRC compliance checks.

The system is now working better than it ever has and contractors are reporting fewer difficulties in getting taken on for jobs.

Inside or outside IR35

‍A contractor who is ‘inside IR35’ is put on PAYE and is regarded as akin to an employee but does not have the same rights as one.

Workers who are ‘outside IR35’ are seen as contractors and pay tax via self assessment.

The same worker can be inside IR35 or outside IR35 on different jobs.

Why was IR35 introduced?

‍IR35 dates from 1999 and was brought in after the Treasury and HMRC had become concerned that people who met the legal tests for being employees were working as contractors via a personal services company (PSC) and thus most likely paying less tax and national insurance.

Companies also benefited from using these ‘disguised employees’ as it kept their head count down and reduced their staffing costs.

Who determines IR35 status?

‍In the public sector the entity hiring the contractor is responsible for determining status. From 2021 medium-sized and large businesses also determine status; however, where the client is a small business determining status is up to the contractor’s intermediary, which may be the contractor’s own limited company.

Where the deemed employer is responsible for determining the contractor’s tax status it must produce a status determination statement (SDS), giving its reasons for the determination.

What determines IR35 status?

‍The factors that determine if a worker is inside or outside IR35 are essentially the same as the ones that govern whether someone is employed or self-employed. These are:
• substitution – can the worker send someone else to do the job?
• control – how much autonomy does the worker have over how, where and when the work is done?
• mutuality of obligation – can the worker choose to not accept the work and can the client choose not to offer it?
• risk – who takes the financial risk of the arrangement?
• equipment – who provides the necessary tools for the job?
• payment – is the worker paid periodically or on completion of the job?
• number of clients – can the worker have multiple clients?

The website gov.uk provides a tool, Check Employment Status for Tax (CEST), [please add link https://www.gov.uk/guidance/check-employment-status-for-tax] that enables employers, PSCs and contractors to check contractors’ status. However, there have been reports that it has reached inaccurate determinations and in some cases has not been able to reach a determination at all.

However, HMRC updated CEST in April so the hope is that it is now more reliable. Indeed, HMRC says it will stand by the determinations generated by the tool so long as the information put into it is accurate.

Problems with the rules

‍IR35 can lead to unfair treatment as workers deemed to be inside IR35 will pay income tax and national insurance as if they are employees but do not get staff benefits such as holiday and sick pay.

Also those deemed inside IR35, whether rightly or not, lose out on being able to pay corporation tax, which is levied at lower rates than income tax, and cannot take profits as dividends, which are also taxed at lower rates than income tax. It has been estimated that contractors working through their own limited companies can lose up to 30% of their take-home pay because of IR35 rules classifying them as employees.

Many clients prefer to take on workers who are outside IR35 because they don’t have to do their tax and national insurance for them and don’t have to pay employer’s NI or contribute to a pension.

On the other hand, companies can be wary of taking on contractors who are outside IR35 because they think they will have fewer problems with HMRC if they deduct tax at source.

And some people who have gone self-employed simply won’t work inside IR35 because they are not willing to lose the benefits of self-employment.

Another issue is umbrella companies that entice contractors to work for them by promising they will pay less tax and NI by means of various contrivances. Some of these schemes are dubious and can have adverse consequences for contractors if HMRC finds they have broken the rules.

Many contracting professionals are extremely unhappy with the rules as a result but there are no signs of an overhaul except in the improbable event that the Conservatives win the next general election. Shadow business secretary Andrew Griffith told the party conference in October that the Conservatives would overhaul IR35 if they took power.

Lineker 1-0 HMRC

‍In March 2023 Gary Lineker won a £4.9 million tax battle with HMRC. The taxman had claimed the then Match of the Day host should be classed as an employee of the BBC and BT Sport. However, since Lineker had signed his contracts personally the IR35’s provisions did not apply, which led to the tribunal decision in his favour.

Jeremy Vine, known for TV series Eggheads and Points of View, is embroiled in a dispute with HMRC, which is claiming he should have been classed as a BBC employee, despite the corporation earlier bringing in a policy of encouraging stars to set up personal services companies.

Loose Women presenter Kaye Adams finally came out on top after a nine-year dispute with HMRC, which was pursuing her for £124,000 in income tax and NICs.

High-profile public sector tax disputes

‍Public sector organisations have had to pay out large sums after disputes with HMRC went against them. In 2022 NHS Digital reached a settlement of £3.95 million with HMRC in respect of IR35 compliance errors from 2017 to 2022. Also in 2022 the Department for Environment, Food and Rural Affairs reached a final settlement of £86.5 million relating to errors in assessing the IR35 status of contractors.

Help with IR35

‍IR35 poses challenges for contractors and employers alike, and determining employment status is complex and fact sensitive. While HMRC may in some cases send ‘nudge’ letters if it thinks there may have been a status determination error, its full array of interest charges, penalties and fines can be brought to bear on those who have made mistakes. And, as is evinced the high-profile cases mentioned above, it can be tenacious in going after those it thinks are not paying enough tax.

You may find it helpful to read Finsbury Robinson’s practice updates on IR35, IR35 and Off-Payroll Working and IR35: What Happens When It Goes Wrong

However, for bespoke advice about any aspect of IR35 please contact Finsbury Robinson directly. We are a full-service tax, accountancy and business advisory firm, and our friendly and highly experienced team is available on 020 8858 4303 or via email at info@finsburyrobinson.co.uk

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