Planning to go freelance? What you need to know about IR35
Considering launching a new career as a freelancer or consultant? Here’s what you need to know about IR35 – and how to work out whether you’re in or out of it.
There’s so much to consider when going freelance or becoming a consultant. From deciding whether it’s better to be a sole trader or limited business, to working out how you’ll find clients and how much to charge.
But probably one of the most confusing aspects of freelancing or consulting is IR35. To help you understand how it works and, importantly whether you need to be in or out, Matt Poyser, director of customer experience at inniAccounts has prepared this definitive guide for us.
What you need to know about IR35
If you are considering leaving permanent employment to become a contractor or freelancer then there will be lots of things you need to put in place. Whether it’s more flexible childcare through to professional indemnity insurance there’s plenty to think about.
Top of the list should be tax, and in particular making sure your business complies with IR35.
To give some background, in 2000 a specific piece of legislation – referred to as IR35 – was brought it to stop an employee from leaving their permanent job and then returning as a contractor to perform their old role in a bid to avoid paying tax and National Insurance at the higher rates.
Unfortunately, it’s quite a complicated piece of legislation to get to grips with, and your IR35 status can change depending on the terms of the contract you take.
But it is worth taking the time to understand it because if you don’t and fail to comply you will end up with a hefty tax bill – HMRC regularly investigates people it thinks are operating outside of IR35 but who should be operating within it and will expect the tax avoided to be repaid.
Are you in or out of IR35? And what’s the difference?
Essentially you need to know if you are working inside IR35 or outside IR35. If you work inside IR35 then you will be taxed as though you’re an employee – PAYE and NI.
If you work outside IR35 then you will calculate pay and tax differently, taking advantage of the personal allowance and use a dividends model to pay yourself.
It can make a considerable difference to your take home pay (if you work inside IR35 you will take home less). To help you get it right, here are the main points you need to know.
How to test your IR35 status
First of all, IR35 applies to any sector; not just IT as many people seem to think. Secondly, most people fall outside of IR35, but it’s not wise to assume that’s the case as you could inadvertently fall foul. To test your IR35 status, there are two questions you need to answer.
1) Is your contract a contract of service or a contract for service?
This is where the semantics are important. Your contract, or standard terms and conditions that you issue to the client or agency that helps you find work, is a legally binding document. And it needs to define your relationship with the client, as well as outline your working practices and services that you are providing for the specific job.
The core areas that need to be present in the contract so that you fall outside of IR35 are:
- Control – it should be explicit that you control how the work is completed and that you provide a service through your own methods. Note that even if your contract does not state it, but the client has a say in when you take time off, approves it, or sets your working hours it could be deemed as being an employee like relationship so fall within IR35. Of course, some common sense might need to be exercised on control because it might not be practical to work other than in the client’s premises and or complete the work other than in a particular way, for instance because of organisational structure or legal obligations.
- Substitution – there should be the opportunity to substitute you for another suitably qualified person, or sub-contract whilst retaining the control and risk associated with this.
- Mutuality of obligations – outlining the obligations of each company you work with to ensure that there is no obligation for further work when the contract ends (as would be expected by an employee). The contract needs to state a clear end date or termination of the contract based on the completion of the project or delivery of the contracted outcome.
- The right of dismissal – notice periods are seen as indicative of employment by HMRC and so the client should have the right to terminate the contract immediately in the majority of circumstances, however some short notice periods can be defendable. If a contractor can’t terminate the notice period immediately, or has a notice period of longer than one month, they are deemed as working under IR35.
Make sure that your contract with the client states your relationship (i.e. you are the contractor/service provider and that they are the client). If you will work with a client for a sustained period of time, then it is really important to maintain the professional boundaries set out within the contract and within the IR35 guidance notes provided by HMRC.
It’s worth knowing that HMRC offers advice to all contractors and you can submit a contract and basic outline of the work for review and feedback.
2) Do you act as an employee or a self-employed entity?
Of course, having a well-drafted set of terms and conditions or contract is not enough. You need to be able to demonstrate that the clauses are true to your working practices.
It is critical that you act and work as a separate entity to your client to fall outside of IR35. Your working practices need to reflect that you have a business to business relationship with your client. There are things you can do to help when you set up the business:
- Provide your own insurance.
- Work with many clients at once (or have the ability to do so).
- Accept a certain amount of financial risk, for example rectifying errors at your own expense. It’s a good idea to set out remuneration terms and amounts in the contract and fixed price quotations are favourable, especially with clauses that state the client won’t pay if things need to be put right.
- Show that you are responsible for your success or failure as a business entity.
- Undertake your own training and provide your own equipment, such as a laptop and particular software. However, to maintain standards, you are not penalised for receiving training from a client if it helps you carry out the specific task stated in the contract.
- Don’t accept employee benefits from your client. This includes parking spaces, ID and security passes that don’t state you are a visitor or contractor, business cards, or use of a subsidised staff canteen for example.
- Always have the intention to be self-employed and invest in your business – the points above all contribute to this as does having your own website, email address, carrying out your own advertising, and having trade marks, for example.
Be prepared – evidence is the best defence
Get ready to document your working relationship. As well as keeping accounts there are other useful documents that will show your independent company status:
- Insurance policies and schedules – you can keep the schedule for as many years as you can, but five as a minimum for your Professional Indemnity cover.
- Business premises proof – lease or contract for premises and utility bills.
- Contracts – for all engagements with clients, especially the long-standing relationships.
- Efficiency gains – tenders and proposals for fixed-price job gains.
- Proof of assistance – employee records, accounting records.
- Marketing spend – receipts and briefs for the marketing undertaken. Copies of advertising and marketing materials.
- Repair at own expense – contract clauses, details of mistakes rectified, details of costs incurred by you to rectify your mistakes.
- Client risk – accounting records of write-offs, copies of correspondence with client involved, legal action records.
- Business entity – receipts for production as well as copies of the materials such as websites, business stationery and branding such as trade mark applications.
- Billing – invoices and correspondence related to payment terms.
- Substitution – contact clauses, level of sign-off by the client, payment terms, audit trail of previous substitutes and subcontracting.
Read more: HelloBonsai has worked with 150,000+ freelancers (most of who are in the top 1% category in terms of earnings), and asked what their top mistakes were while using contract templates and how they would avoid it.
Don’t panic about IR35!
Finally, don’t panic. There is nothing wrong with operating within IR35 so long as you pay the correct levels of tax and NI through PAYE.
If you are embarking on a contract with the public sector, then there are some nuances that you need to be aware of and it cam be complicated to get it right.
If you find yourself in this situation, are unsure of how to navigate things anyway, or don’t know how to work out the tax you pay through PAYE, then get help from an accountant.
But note that some accountants will shy away from helping, so look for one that specifically works with contractors and freelancers. This will give you peace of mind and let you get on with your day job and reap the lifestyle benefits of being a freelancer.
Matt Poyser is director of customer experience at inniAccounts, online accountants for freelancers and consultants.
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