Working with freelancers or contractors can provide wonderful opportunities for businesses to complete work, get help on certain projects, or even solve recurring problems without hiring full-time employees.
But thanks to IR35, hiring contractors or freelancers can become a stressful experience when trying to work out contracts around IR35 payroll legislation. And if your business gets caught out by these rules, you could be overpaying on tax or worse, face an investigation and hefty fine from the HMRC.
In this guide, we’ll outline exactly what to do to avoid IR35 and protect your company from expensive mistakes or investigations.
Remind me: what is IR35?
IR35 is a tax legislation in the UK designed to prevent disguised employment. Basically, it’s a way of preventing tax avoidance through companies saying their employees are contractors. You can find more information in this guide to IR35, but here’s the basics:
- If companies have employees, they must pay the correct taxes and National Insurance contributions and pay the employees through a PAYE payroll system.
- If an employer hires a contractor or freelancer, the company cannot extend employee benefits to these workers. If they are found to have employee-level benefits, then companies will be liable for not complying with IR35. That means hefty fines (such as an extra 25% on top of your tax bill) and stressful HMRC investigations.
The difficult part of IR35 is that there can be a grey area in determining whether someone falls inside (an employee) or outside (a contractor) of the legislation. That’s why we’ve put together this information to help avoid IR35.
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Top tips on how to avoid IR35
Want to make sure you’re not hit with hefty fines or overcharged with your tax from IR35? Follow these tips to make sure that you learn how to avoid IR35 and your business stays compliant.
1. Check your contracts
First up, one of the best ways to avoid IR35 is to check the contracts that you currently have and make sure that they are correctly outlining the work and how it differs from an employee contract.
The key things that you should highlight here are:
The hours and set working conditions
Employees have set hours and timeframes that they work, while contractors set their own conditions and schedules.
Holiday and sick pay
Employees are entitled to leave and will still receive pay. Contractors do not get this benefit and won’t be paid for days they did not work.
Long-term commitment
Employees are committed to the company for long periods, whereas contractors are not tied into contracts. They can leave at any time, where employees will be required to serve a notice period.
Contracts with other companies
Employees usually work for one company and often have clauses in their contract that prevent them from taking on work outside of this arrangement or working with direct competitors. Contractors are not under these obligations and are free to take on projects from other companies.
If you have any contracts that are unclear, you may want to take legal advice from a solicitor.
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2. Keep your correspondence
It’s worth keeping a record and a backup of all emails or correspondence with your worker, in case that you do come under IR35 investigation. These emails can provide further evidence of your working relationship with the worker and the details of the work that is carried out.
For example, if a contractor has emailed you with advance warning that they will be unavailable as they’re taking a holiday, that’s proof that you don’t determine their holidays and that you don’t control their working hours or conditions.
3. Don’t give them branded materials
Freelancers and contractors work for themselves, which means that they have separate branding and materials for their work that are separate from your company.
That divide will act as supporting evidence for your classification, so it’s important that you don’t muddy the waters by supplying contractors with branded material such as business cards.
In addition, it might be a good idea to avoid creating a dedicated office space for contractors. If they work from home, on their own equipment, you help maintain the divide.
4. Request a personal business insurance
When working as a contractor or freelancer, some companies require that they take out certain types of business insurance, like professional indemnity insurance.
If your worker has individual, personal insurance, it’s another piece of evidence that they’re not an employee and work for themselves.
Speaking of insurance, it’s a great idea to make sure that your business is also covered for any unlikely situation. If you’re unsure what type of insurance that you’ll need, you can find all the answers in this guide to business insurance for sole traders.
5. Submit your Status Determination Statement (SDS)
A Status Determination Statement (SDS) is a written statement stating the employment status of a worker.
An SDS should include how you have come to the classification decision and could list the supporting evidence to back up your claim. These statements also need to prove that you have followed IR35 instructions with ‘reasonable care’.
This means that you have to make a fair and well-considered decision that incorporates the following factors.
Personal service
This looks at whether the contractor is required to complete the work personally, or if they have the right to substitute the work in order to meet demand. For example, an employee will be obligated to complete their work themselves, whereas a contractor could enlist help or outsource to complete a project.
Mutuality of Obligations (MOO)
This doesn’t just have the best acronym in IR35 but refers to obligations when accepting or offering work. With employees, they have an obligation to accept all work the company offers, and likewise, the company has an obligation to provide work for their employees. For contractors, this obligation does not exist.
Control
Finally, this point looks at the level of control that the company has over the worker, including aspects such as setting work hours or working conditions. Contractors should have the freedom to set these conditions themselves and not be under the company’s control.
Once a Status Determination Statement is created it will need to be passed on to the worker and any other parties that are involved in this employment.
For example, if a contractor was hired from an agency, the agency would also need a copy of this statement to have agreement across all parties.
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What else can businesses do to avoid IR35?
If you’re looking for other ways to stay compliant and learn how to avoid IR35, businesses can also consider the following three options.
1. Stop working with independent freelancers
One of the easiest ways to avoid IR35 is to avoid working with independent contractors and freelancers entirely. If you don’t have any contractors, you can’t come under fire for incorrectly taxing them.
However, this isn’t a real solution. It’s avoiding the problem and could potentially put your business at risk by turning away talented contractors and freelancers that you need.
2. Use CEST
CEST is HMRC’s ‘Check Employment Status for Tax’ tool, which you can find on their website here.
This tool is designed by the government to help you decide how to classify your worker’s employment status if you’re ever unsure. You can enter the details and information of their contract, and it will return an employment status for your company.
All statuses that are given by this tool are used for official determinations and investigations, which you can keep as part of your own records. However, this only works as long as the details you entered are accurate. If there are any changes to the contract entered, then the results may not be accurate.
The downside of CEST is that it’s not the fastest tool or option out there and can be slow to return a decision. In addition, although you’ll get a result, you won’t get much support and won’t be able to use the result if any information you enter changes.
3. Buy an IR35 product or service
If you are still struggling to understand how to avoid IR35 and stay compliant, a lot of companies are offering dedicated IR35 products or packages, so you can offload the work to someone else.
However, these solutions may be expensive and not worth the cost for some SMEs.
How to avoid IR35 – A summary
IR35 is legislation that’s there to prevent employees from posing as contractors to avoid tax. Provided that you do not fall under this category, businesses can avoid paying unnecessary tax or be under fire for an investigation by:
- Making sure that you have a clear record and contract for your workers and ensure that they are not being treated or receive employee benefits
- Create Status Determination Statements to determine the status of all your workers, which are then shared with all parties involved
- Keep evidence of your worker’s classification
And of course, if your worker does fall under the employee classification, you are then under obligation to follow IR35 rules and pay them through a PAYE system that automatically deducts tax and National Insurance payments.
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