Understanding IR35: What Does Outside IR35 Mean Explained

IR35 is a term that is commonly used in the UK to refer to the tax legislation that was introduced in 2000, aimed at tackling what the HMRC calls ‘disguised employment’. IR35 applies to contractors working through a personal service company (PSC) who would otherwise be considered an employee for tax purposes if the PSC was not used.

When a contractor is deemed to be inside IR35, it means that the contract and working practices are such that their employment status is similar to that of a traditional employee. As a result, they are required to pay income tax and national insurance contributions (NICs) in the same way as an employee.

On the other hand, when a contractor is deemed to be outside IR35, it means that the contract and working practices indicate that they are operating as a genuine business and not as an employee. As a result, they are not required to pay income tax and NICs in the same way as an employee.

It is important to note that the determination for whether a contractor is inside or outside IR35 is based on the actual working practices and not just the contract. This means that even if a contract states that a contractor is outside IR35, if their working practices indicate otherwise, they will still be considered inside IR35.

In April 2021, following the introduction of IR35 legislation in the public sector in 2017, the responsibility for determining whether a contract is inside or outside IR35 shifted to the end client in the private sector for medium and large-sized businesses. Small businesses remain exempt from this responsibility and therefore the contractor retains the responsibility for determining their IR35 status.

Overall, understanding IR35 and the implications of being inside or outside IR35 is crucial for contractors and businesses alike.

Key Takeaways

• IR35 is tax legislation introduced in 2000 aimed at tackling ‘disguised employment’.
• Contractors working through a personal service company (PSC) who would otherwise be considered an employee for tax purposes if the PSC was not used are affected by IR35.
• When a contractor is deemed to be inside IR35, they are required to pay income tax and national insurance contributions in the same way as an employee.
• When a contractor is deemed to be outside IR35, they are not required to pay income tax and NICs in the same way as an employee.
• The determination for whether a contractor is inside or outside IR35 is based on the actual working practices and not just the contract.

The Basics of IR35 and Contractor Classification

IR35 is a tax legislation that applies to contractors in the UK, to prevent tax avoidance by those who work as self-employed but have an employment status for tax purposes. The IR35 status determines if a contractor is considered an employee or self-employed for tax and National Insurance Contributions (NICs) purposes.

Inside IR35 refers to a contractor who is deemed to be working as an employee of the client and, therefore, liable to pay income tax and NICs. On the other hand, working outside IR35 means that contractors are operating as a genuine business and are responsible for managing their tax liability and responsible for paying their income tax and NICs.

The main factors that determine if a contractor is inside or outside IR35 are their employment status, working practices, and the terms of their contract. The Mutuality of Obligation (MOO) principle, which means that an employer is obligated to provide work, and the employee is obligated to accept it, is an important aspect of IR35 contract review.

Private sector contractors running limited companies or Personal Service Companies (PSC) were the primary focus of IR35 before its expansion to the public sector in 2017. Following the introduction of IR35 legislation in the public sector, end clients are responsible for determining whether a contract is inside or outside IR35. Direction and control, as well as substitution, are some other key factors that determine whether a contract is for services or a contract of service, which is crucial in determining whether IR35 applies.

While operating outside of IR35 means you pay less tax, contractors working inside IR35 will have less financial responsibility and receive employee benefits such as sick pay. A contract inside IR35 must pay both income tax and NICs as an employee and have actual working practices that align with the terms of their contract. If a contract is considered inside IR35, the tax liability can run into tens of thousands of pounds, so it is important to ensure that you are truly self-employed and are operating as a genuine business. Paying oneself a salary and the remainder of the income as dividends is an effective way for contractors to do this.

Umbrella companies can often be useful for those who work inside IR35. These companies provide employment contracts for those who are deemed as employees and pay the appropriate tax and NICs.

Overall, carefully reviewing the contract and working practices, able to demonstrate independence from the client and taking steps to operate as a genuine business, are crucial factors in determining whether IR35 applies to a contract.

Understanding the Implications of Working Outside IR35

When a contractor is deemed to be working outside of IR35, they are considered to be operating as a genuine business rather than an employee for tax purposes. This means they will pay less tax and National Insurance Contributions (NICs) than if they were inside IR35.

However, to be considered outside IR35, the contractor must be able to demonstrate that they are truly self-employed and not working as an employee. This involves a contract and working practices that fall outside the definition of a contract of service, which is characteristic of being inside IR35.

Accountants and Personal Service Companies (PSCs) can help contractors who are working inside IR35 by providing services rather than a contract, which can place them outside IR35. This can be particularly important in the private sector, as contractors who are working inside IR35 will have to pay income tax and NICs as if they were an employee.

If you’re inside IR35, also known as ‘inside IR35’, you will have to work through a Personal Service Company (PSC) or an umbrella company. Public sector contractors have been affected by IR35 since 2017 and, following the introduction of IR35 legislation in April 2021, private sector contractors have also been affected.

The key differentiator between working inside or outside IR35 is the level of direction and control the end client has over the contractor’s work. If the contract is inside IR35, the contractor is considered to be providing a service and is subject to employment taxes. If the contract is outside IR35, the contractor is operating as a genuine business and is responsible for managing their own tax liability and paying taxes accordingly.

Contractors should use an IR35 calculator to determine whether IR35 applies to their contract and work status. It is important to note that a contract must reflect actual working practices and that the end client is responsible for determining whether a contract is inside or outside IR35.