IR35 is the common name for UK tax legislation that targets "disguised employment." It applies when someone works through their own company (often called a Personal Service Company) but would be considered an employee if they were engaged directly. The rules ensure that these workers pay similar taxes to employees rather than gaining tax advantages from company structures.
How IR35 Works
If a contractor's working arrangement falls "inside IR35," they must pay income tax and National Insurance as if they were employed, eliminating most tax efficiency benefits of working through a company. The key question is: would this person be an employee if they were contracted directly without their company in between? If yes, IR35 applies.
Who Determines IR35 Status?
For medium and large businesses in the private sector (and all public sector organizations), the client hiring the contractor must determine IR35 status. Small businesses in the private sector leave this determination to the contractor. Getting the determination wrong can result in significant tax liabilities, interest, and penalties for the responsible party.
Key Factors for IR35 Assessment
- Control: Does the client dictate how, when, and where work is done?
- Substitution: Can the contractor send someone else to do the work?
- Mutuality of obligation: Is there an ongoing obligation to provide and accept work?
- Financial risk: Does the contractor bear genuine business risk?
- Integration: Is the contractor integrated into the client's organization?
Consequences of IR35
If a determination is wrong and HMRC later decides IR35 should have applied, the fee payer (often the agency or client) becomes liable for unpaid tax, National Insurance, interest, and potentially penalties. This liability can extend back several years. Many businesses have responded by being more cautious about contractor engagements or converting contractors to employees, sometimes using EORs to ensure compliant employment relationships.