What is IR35?
IR35 is a law that was introduced in 2000 to tackle the problem of “disguised” employment.
Because contractors and freelancers pay less income tax and NIC (National Insurance Contributions), many workers had set up limited companies or personal service companies to work as contractors instead of employees. HMRC believed that many of these contractors/freelancers were essentially employees.
IR35 are the set of rules which apply if you work for a client through an intermediary – i.e. through a limited company or personal service company. In other words, although there is an intermediary, to all intents and purposes you are essentially an employee – what HMRC calls a “deemed employee”.
So, with the advent of IR35, contractors had the responsibility of showing to HMRC that they were actually contractors (outside of IR35) and not deemed employees (inside of IR35).
What is Changing in IR35?
Changes to IR35 will come into effect in April 2020 and will see the transfer of this responsibility shift from contractor to the employer/client. This change brings private sector work in line with the public sector (in the public sector, it is already the employer/client’s responsibility to show that the contractor is outside of IR35).
IR35 only applies to medium and large sized employers – small companies are exempt. Broadly speaking, a small sized company is one that has 2 of 3 things:
- A turnover of less than £10.2million
- A balance sheet of less than £5.1m
- No more than 50 employees
Why You Should Be Concerned?
More than two thirds of freelancers are unaware of this change to IR35, even though the impact of this change could be considerable. If you are deemed to be within IR35 – your net income could reduce by as much as 25%.
This is because now, the employer/client will decide whether the client is paid gross or taxed at source. If the employer/client decides that the contractor is within IR35, they will be taxed (income tax and NIC) and less money will be paid to the contractor.
It is unclear what affect the changes will have. 43% of businesses are unsure as to how IR35 will affect their business, whilst around 24% said they would postpone projects as a result. Freelancers should at the least be aware that their earnings could fluctuate when IR35 comes into force.
To determine your status, your employer/client will probably refer to HMRC’s CEST tool. As a contractor you may be consulted by the employer/client when determining your status – however you have no statutory right to be consulted.
How Will Your Employer/Client Decide Determine Your Status?
Your employer/client will determine your status by looking at three main criteria.
To show that you are not an employee, you have to show a degree of autonomy, which should be reflected in your written contract. Your working practices also need to show that the employer/client has no control over how you perform your work.
If your written contract/working practices indicate that:
- You will be supervised
- You receive staff benefits such as holiday and sick pay
- You have start, end and break times
Then this would suggest that you fall within IR35.
Substitution is another important factor that will determine IR35 status. If it is stipulated in your contract that a different contractor can complete your work – this suggests that you are outside of IR35. This right to substitute must be a genuine one and one that the employer/client agrees with.
Mutuality of Obligation
The third test is whether the you are obliged to take on work that is offered to you. If so, this would suggest that you are in employment. What would help your case further is if you are able to work for multiple clients. Any prohibition would suggest that you are an employee rather than self-employed.
Every law has grey areas; with IR35 there is considerable grey area. Case law is complex and some issues are very ambiguous. However, there are a number of things that you can do as a freelancer/contractor to show both your employer/client and HMRC that you fall outside of IR35.
What You Can Do
What better way to show the nature of your working relationship than with a contract that both parties have agreed to. Clearly stating your services means that the client/employer cannot ask you to do anything not agreed in the contract – and this will clearly indicate that you are a freelancer.
Make sure you insert a substitution clause in your contract – another sign that you fall outside of IR35. You should also specify when you want to be paid. Unlike employees, freelancers are often paid late. When this happens you can complain, and this will form another piece of evidence that indicates you are outside IR35.
Employees charge their travel to the company’s expenses account. Show you’re not an employee by paying for your own travel. If there is any equipment that you use, such as computers or work tools, showing that your bought these yourself, for your own company, suggests that you are outside IR35.
Employees have no need for a website design - unless their job is to maintain, create or work for an ecommerce website design system. Make it clear that you’re a freelancer by creating a professional website design or demonstrating that you undertake freelance work for an ecommerce website.
None of these tactics are watertight. HMRC may ignore your contract and everything else if they believe that your real, intended relationship is that of an employer/employee. However, drawing up a freelancer contract and designing a website are relatively inexpensive and straightforward steps that will add value to your business.
Assuming that you work for a medium/large sized company, the onus will be on your employer to decide if you are a contractor or employee. If there’s any confusion, they will err on the side of caution and deem you an employee – so you need to do everything that you can to indicate otherwise. Doing so will only save you time and money in the long run.
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