How to know if you're caught by IR35 and what it will cost you

In the world of contracting and freelance work, IR35 is a term that has stirred confusion and concern for many. Whether you’re operating through your own limited company or working as a freelancer, understanding IR35 is crucial for your tax obligations. Getting it wrong can result in significant financial penalties. This article will explain how you can determine whether you’re caught by IR35 and what the financial consequences are if you are.

What is IR35?

IR35 is a piece of tax legislation introduced by HM Revenue & Customs (HMRC) to determine whether a contractor is genuinely self-employed or if they should be taxed as an employee. The law aims to prevent tax avoidance by individuals who, despite working as contractors through an intermediary (like a limited company), are essentially working as employees of their clients.

If you are caught by IR35 (i.e., if your work falls “inside” IR35), you will be taxed similarly to an employee, meaning you’ll pay income tax and National Insurance contributions (NICs) at a higher rate.

How Do You Know If You Are Caught by IR35?

Determining whether you are inside or outside IR35 isn’t always straightforward. The decision depends on various factors, primarily focused on the relationship between you (the contractor) and your client.

Here are the key factors that HMRC looks at when deciding if you’re caught by IR35:

  1. Control

    2. Control refers to the extent to which your client dictates how, when, and where you do your work. If your client has significant control over your working methods, hours, or location, this may suggest an employment relationship.

    • Inside IR35: Your client has direct control over your tasks, schedule, or approach to work.
    • Outside IR35: You have the freedom to decide how to carry out your work, showing that you’re in control of your business.
  2. Substitution

    3. Substitution is about whether you can send someone else in your place to carry out the work. If your contract or working arrangement allows you to bring in a substitute, you are likely to be considered outside IR35.

    • Inside IR35: If you are expected to personally carry out the work and can’t send someone else, it suggests an employment relationship.
    • Outside IR35: If you have the right to substitute someone else, it’s more indicative of self-employment.
  3. Mutuality of Obligation (MOO)

    4. This refers to whether there’s an expectation of continuous work. In an employment relationship, there’s usually an ongoing obligation for the employer to provide work and the employee to accept it. If there is no such expectation, you might be considered outside IR35.

    • Inside IR35: Your client expects you to work continuously, and you are obligated to accept the work.
    • Outside IR35: The work is more project-based or temporary with no obligation to accept future assignments.
  4. Financial Risk

    5. As a contractor, you are expected to bear some level of financial risk in the business. This includes the risk of not being paid if the work isn’t completed to the client’s satisfaction or on time.

    • Inside IR35: You are paid a fixed salary, with no real risk of financial loss or gain.
    • Outside IR35: You take on financial risk, such as penalty clauses for missed deadlines or payment only after project completion.
  5. Exclusivity

    6. If you are working exclusively for one client, it may suggest an employment relationship, particularly if the work is full-time or ongoing. Self-employed contractors typically have multiple clients.

    • Inside IR35: If you’re working full-time for one client, with no flexibility or choice in the matter, this could be an indicator of employment.
    • Outside IR35: You work for multiple clients or have the ability to work for different businesses simultaneously.

How to Check Your IR35 Status

If you’re unsure whether your contract is inside or outside IR35, there are several ways you can check your status:

  1. HMRC’s CEST Tool

    2. HMRC offers a Check Employment Status for Tax (CEST) tool to help contractors determine if their work falls inside or outside IR35. However, the CEST tool has faced criticism for its lack of reliability in some cases. While it can be a helpful starting point, it's important not to rely on it entirely.

  2. Seek Professional Advice

    3. If you're still in doubt, seeking expert advice from an accountant or IR35 specialist can help ensure that your contract and working arrangements are properly assessed. For more tailored guidance, consider reaching out to our team of experts, who can help you navigate the intricacies of IR35.

  3. Get a Status Determination Statement (SDS)

    4. For medium and large businesses hiring contractors, the responsibility of determining whether a contract is inside or outside IR35 falls on the client. If you’re working with one of these clients, they are required to provide you with a Status Determination Statement (SDS). If you disagree with their decision, you can dispute it.

What Will It Cost Me If I’m Caught by IR35?

If you are deemed to be inside IR35, the financial implications can be severe. Here’s what it could cost you:

  • Income Tax:

    • When you are caught by IR35, your income is treated as salary, meaning you will pay income tax at the normal rates. The amount you pay will depend on your earnings, but the highest income tax rate is 45% on earnings over £125,140 for the 2024-2025 tax year.

  • National Insurance Contributions (NICs):

    • In addition to income tax, you will also be liable for Class 1 NICs, which are deducted from your salary. Employers also pay NICs on your income, but when you're inside IR35, the whole amount is treated as salary and subject to both employee and employer NICs. The employee NIC rate is currently 8% on earnings between £12,570 and £50,270, and 2% on earnings above £50,270. The employer NIC rate is 13.8% on income above £9,100.

  • Loss of Tax Efficiency:

    • One of the key benefits of being outside IR35 is the ability to take income as dividends, which are taxed at a lower rate than salary. If you are inside IR35, you lose this advantage, and all your income is treated as salary.

  • Potential Penalties

    • HMRC has the authority to impose penalties if they determine that you have misclassified your employment status. The penalty amount will depend on the nature of the non-compliance:

    • 30% of the unpaid tax if HMRC believes you were careless in assessing your employment status but did not intentionally misrepresent it.
    • 70% of the unpaid tax if HMRC finds that you were aware that you were within IR35 but chose not to act accordingly.
    • 100% of the unpaid tax if HMRC concludes that you deliberately concealed your IR35 status and attempted to evade tax.

    To better understand how IR35 affects your finances, consider using our IR35 Tax Calculator. It’s a simple way to assess your potential tax liabilities and make informed decisions. Try it now.

    How Can I Protect Myself from Being Caught by IR35?

    To avoid falling inside IR35, here are some tips to ensure you maintain your self-employed status:

    • Review your contract: Make sure your contract clearly shows you are running a genuine business, with freedom in how you work and no obligation to accept ongoing work.
    • Focus on your working practices: Ensure that your working practices reflect a business relationship, such as having multiple clients and the ability to substitute workers.
    • Diversify your clients: Avoid working exclusively with one client, as this increases the likelihood of being deemed inside IR35.
    • Seek expert advice: Consult with a tax expert or IR35 specialist to ensure your contract and working practices are compliant.

    IR35 is a complex and often confusing piece of legislation, but understanding it is essential to avoid costly tax consequences. By reviewing your contracts, considering your working practices, and seeking professional advice, you can better assess whether you're inside or outside IR35.