What is IR35

IR35 it’s big, it’s bad and it’s all over your newsfeed! But what is it? And why do you need to know anything about it? Let me take you on a journey to explain what IR35 is and why it’s important. 

A freelancer greeting friends at a party

“IR35 is a piece of legislation which the Treasury introduced back in April 2000. This was a response to common tax loophole named “the Friday to Monday scenarios.”

What is IR35?

So, IR35 let be honest before we start, it’s not new, it hasn’t really changed since its inception in April 2000, and most of the time HMRC loses cases due to the fact proving an employment relationship exists in a contract assignment is, well very difficult!

Now, if you work in recruitment, UK umbrella industry, use LinkedIn or are in fact a contractor operating through your own Personal Service Company (PSC) then you are probably tracking whats happening in the private sector regarding IR35. It’s a big change but let’s step back and look at what IR35 is and then look at what the changes mean.

Right, what is IR35? IR35 is a piece of legislation which the Treasury introduced back in April 2000. This was a response to common tax loophole named “the Friday to Monday scenarios”. Essentially the authorities had noticed that employees were finishing a permanent role then returning to the same employer as a PSC contractor which allowed them to benefit from a more favourable tax rate. Back then, the difference was around 20% more income.

This practice had to be halted as HMRC were losing out on valuable tax revenue. Thus was born the “Intermediary legislation”(IR35). This new law was introduced to set strict guidelines on who can operate as a PSC contractor in the UK and who is, in fact, a disguised employee (tax avoider!). The legislation set out to assess if the PSC Contractor was working as an independent resource contracted for a specific role or acting as an employee. The table displays how may investigations HMRC has conducted since 2002 and the total review recovered each year.

Recovered Revenue

What does HMRC judge IR35 on?

How do you test this I hear you say! Well, the key items HMRC would look at are:

PSC contractor diagram

Really clear right???? No, it’s not so please let me show you an example of how a PSC contractor should be engaged. Let’s say you want to build an extension on to your house, you hire a builder to complete this work and engage them for the total amount of time the project will take (not 1 month at a time). If they are not any good your replace them. You also do not invite them in for lunch and dinner, and if they do not know how to fit windows, you will not pay extra for them to attend a training course. You do not advise them how to do the work (let’s be honest what do you know about building extensions), equally if the main person who is conducting the work cannot come over for a week, you will happily let them send someone else as long as the work is still getting done.

Additionally, if they finish the work and the roof leaks, you will request they fix it at their own cost as they have failed to deliver the project without fault.

The above is a simple example of a PSC contractor who is outside of IR35 in a way I hope most people can understand. If not, I invite you to google the Shepherd example HMRC published (and by shepherd I mean a person who herds sheep).

The above is a simple example of a PSC contractor who is outside of IR35 in a way I hope most people can understand.

Why is IR35 so popular now 20 years on?

Now we have a cleanish idea of what IR35 is, let’s talk about why it’s so popular right now. Currently the person in charge of managing a PSC contractors IR35 status has been the contractor themselves (yes it’s like starting a diet and locking the chocolate in a box but then keeping the key in your pocket). HMRC for obvious reasons does not feel the contractors are best placed to determine their IR35 status as so much of the key items are in the control of another party, namely the Client who is utilising the PSC contractors services.

So as of April 2021, HMRC will move the responsibility of determining the IR35 status of a PSC contractor to the Client! HMRC did this in the public sector in 2017, which caused mass panic and a blanket ban of PSC contractors in some parts of the local and central government. As of today, some of these bans still exist but you will now find PSC contractors on specific projects (flexible workforces are needed after all).

It’s a big deal as now the Client has the possibility of financial penalty for not taking reasonable care to determine the status of a PSC contractor before engaging them. This change as led to some large organisation already making a statement advising that post-April 2021 will not engage PSC contractors due to the financial risk. This has upset a lot of professional contractors as they are now being dictated too as how they can operate there own business, and no one really likes to be told what to do, even more so when it affects your income.

And this is where we are right now, the contracting marketplace is in turmoil and in my following articles I will dig into more detail regarding specific issues and information about what can be done to help, who it affects and why.