What is IR35?

The ins and outs of IR35 explained

IR35 was originally introduced on April 6, 2000. ‘IR35’ has courted controversy and made headlines but it has also left a lot of people mystified as to its original meaning. What is IR35?

Put simply, it was brought in to counter what the HM Revenue & Customs saw as ‘disguised employment’. A contractual worker fills a permanent position in a company but doesn’t pay the corresponding income tax and National Insurance contributions (NIC) a permanent worker would.

The statement was basically seeking to clampdown on these so-called one-person services companies. That is, individuals who, while ostensibly acting as employees of a company, avoid PAYE by instead charging for their services under a contract.

Under the rules, a contractual worker falls under IR35 if:

  • he or she (the ‘worker’) works for a client but does not invoice the client directly for work carried out, instead:

  • the client contracts an intermediary company, which then effectively employs the worker. It is easier for the client – if dissatisfied – to dispense with the services of the intermediary than it would be if it employed the worker directly. The client also avoids PAYE or NI tax issues

  • the intermediary company, in which the worker has at least a 5% beneficiary interest, then invoices the client for the worker’s efforts

  • the worker takes their earnings in the form of a dividend (a distribution of net profits of the company to its shareholders) on which NIC aren’t paid

Hence, the HMRC argues, the worker is effectively employed but in tax terms is self-employed and is therefore a ‘disguised employee’.

The problem that has arisen is that contractors UK-wide are arguing the HMRC’s cloudy definition of the difference between self-employed and employed workers makes IR35 too arbitrary. As such they want more balanced assessments of what constitutes a ‘disguised employee’.

The reason this is important is because the IR35 regulations only apply to situations where the worker would be deemed to be an employee of the client, if it were not for the presence of the intermediary.

Guidelines exist where at first glance it would be easy to assume the contractor fell under IR35. For example, a contractor can work for a single client for good business reasons without being employed solely by them and the length of the contract in itself is not a factor in determining whether the contractor is caught in IR35.

And if you do fail IR35, the HMRC is obliged to provide an explanation as to why related to your circumstances.

Where the worker is deemed an employee, all earnings of the intermediary company (which effectively becomes an employee itself) become subject to PAYE and National Insurance. In cases where companies have believed themselves outside IR35, this can mean hefty back payments.

It’s important to note that on 6 April 2007, Chapter 9 ITEPA 2003, also known as Managed Service Company (“MSC”) Legislation, was introduced. MSC Legislation applies to individuals providing their services through intermediaries which meet the definition of a Managed Service Company, and an intermediary must consider whether MSC Legislation is applicable to them before considering IR35.

Intermediaries that do not meet the definition of an MSC must continue to consider IR35. If you think you may fall within the scope of IR35, it’s important to seek immediate professional advice from your accountant. Official guidance can be found on the HMRC website.

According to Bloomsbury Professional, HMRC has recently stepped up its investigations into IR35 abuse, increasing its yield from such cases to £1.25m in 2011-12 from £219,000 in the previous year. The heightened vigilance follows chief secretary to the Treasury, Danny Alexander’s speech at the Liberal Democrat conference in September 2012, in which he vowed to crackdown on personal service companies.


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