Whether you are a contractor or freelancer, or a small business that is looking to hire one, you should be aware of IR35 payroll legislation.
Ever since this piece of legislation came in, it has been a source of worry and stress for businesses, and freelancers and contractors alike.
To take out the guesswork, we have put together a list of commonly asked questions about the IR35 rules in the UK to help you navigate this payroll legislation.
What is the IR35 payroll legislation?
It’s a law that covers off-payroll work, which means work carried out by someone other than an employee of a company. In other words: if you, as a business, hire a contractor or freelancer to carry out some work, IR35 payroll rules might apply.
The purpose of this legislation is to prevent tax avoidance. A freelancer or contractor has certain tax benefits, such as allowable expenses, that an employee doesn’t have. On the other hand, employees have advantages, such as paid leave and sick pay, that a self-employed person doesn’t have.
The law makes sure that a self-employed freelancer or contractor can’t get the best of both worlds by being treated as an employee by the company while at the same time being seen as self-employed for tax purposes.
But it’s not just the worker who would benefit from this deception. Businesses have to pay employer NIC for all their employed staff members, but not for contractors.
If HMRC thinks that a contractor is a so-called disguised employee, it can have consequences for both, including fines or a tax avoidance investigation.
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Employers caught with a disguised employee will face hefty fines and penalties for tax avoidance, an extra 25% on top of their final tax bill, and a long and stressful HMRC investigation.
Who needs to know about IR35?
Basically, all self-employed people, such as freelancers and contractors, and everyone who hires them. The law applies to both the private and public sector.
The rules also apply if the owner of a limited company provides their services through that company, not just a sole trader.
Who determines if a contractor is outside or inside IR35?
Employers are the ones responsible for IR35 classifications of their employees, in most cases. However, if the worker provides their services to a small UK business outside the public sector, it’s the contractor’s responsibility.
Whoever is responsible, it’s important that the classification is correct due to the potential consequences of mistakes. If a worker is classified as outside IR35, either by the business or the worker, make sure:
- You have a clear and detailed contract that clearly outlines your role as a contractor, not an employee.
- You don’t receive any employee benefits or are treated as such. It could be a good idea to keep all of your correspondence here as evidence.
For more information on classification, you might want to see HMRC’s CEST (Check Employment Status for Tax) tool on their website.
What happens if I classify a contractor wrongly under IR35?
If HMRC decides that a contractor you hired is a disguised employee, the consequences will depend on whether they believe it was a mistake or deliberate.
In either case, you will have to pay back the tax and NICs on the salary. If HMRC thinks you did it deliberately, or were careless, you will also receive a penalty. And HMRC might decide to conduct a lengthy investigation.
The same will be true if a contractor is subject to an IR35 inquiry by HMRC.
So it’s important that both the client and the contractor make sure that the worker is classified correctly to avoid any issues with HMRC.
What is the 5% expenses rule when inside IR35?
If you work as a contractor inside IR35 for a small business, you are entitled to a 5% deduction of the contracted amount as allowable expenses.
The money deducted is meant to be spent on costs such as training, equipment, office costs, bank charges, stationery, etc.
If you’re unsure if this applies to your situation, it’s best to contact an accountant who can provide you with the right advice.
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How can I avoid IR35 as a business?
To avoid being caught up in the IR35 rules as a business, it’s vital that you treat any contractor as such, and not as an employee. This means:
- Don’t use the same contract as for employees – as contractors and employees have different rights and obligations, their contracts should reflect these differences
- Ask them to take out personal business insurance – this will show that they are working for themselves rather than as an employee of you
- Refrain from providing contractors with branded materials – branded items such as business cards should be reserved for employees to show that contractors aren’t part of the company
- Submit a Status Determination Statement (SDS) – this is a document that details how you arrived at the classification of the worker
These measures will help you avoid falling under IR35 rules. Of course, to be absolutely sure, you could also stop working with freelancers and contractors. However, this could have a negative impact on your business if you rely on that kind of support.
If you want to know more details, read our article about how to avoid IR35 when working with freelancers and contractors.
How can I avoid being inside IR35 as a contractor or freelancer?
If you are a freelancer or contractor, you might also wish to avoid falling under IR35 legislation. Here are the things you can do to ensure you don’t fall foul of the law:
- Make sure the contract clearly defines you as a contractor/freelancer
- Ensure you determine your work hours and if/when you take time off
- Don’t accept payment if you take time off or are sick
- Don’t use any branded material from the company you work with
- Take out personal business insurance if you don’t already have it
- Make sure you pay your taxes and NIC contributions
- Make sure the company classifies you as outside IR35
It’s also worth keeping any correspondence with the company, so you can show that you are working for yourself and not as an employee. For example, if you warned them that you would be off for a week, this will prove that you had determined your time off.
These steps will ensure that you won’t be classed as inside IR35 and avoid any issues with HMRC.
Can I work through a limited company inside IR35?
If you work as a contractor through your own limited company, you can still qualify for being inside IR35 for certain contracts as part of that business.
The change in your tax only applies to contracts that classify as being inside IR35. All other contracts will be taxed as normal for your limited company.
However, if one of your contracts falls inside of IR35, you can choose to work through an umbrella company rather than through your limited company. This means the umbrella company will take on the role of employer and sort your PAYE salary out on your behalf.
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How do I calculate my income inside IR35?
IR35 can be confusing. So to make matters a little easier, we’ll go through an example of what the income and take-home pay would be like for Gene, an IT consultant who runs his own limited company. If you prefer, you can follow the HMRC’s guide to calculate deemed employment payment instead.
Gene has just taken on a contract with a small business for 2 months of work at a total value of £20,000, which is classed as being inside IR35.
The contract is worth £20,000, which is the total income.
Because the client is a small business, Gene can expense 5% inside IR35. That means he has a £1,000 expense allowance. The remaining £19,000 will be used to calculate his tax liabilities.
Firstly, Gene’s company will have to pay Employer’s National Insurance to the HMRC at a rate of 13.8% (tax year 2024/25) – totalling £2,622. This leaves £16,378 as Gene’s take-home pay, which will be liable for National Insurance and Income Tax.
In summary:
| Contract value | £20,000 |
| Allowable 5% expenses | £1,000 |
| Taxable amount | £19,000 |
| Employer NIC payment | £2,622 |
| Take home pay | £16,378 |
The £1,000 from his allowable 5% expenses will go back into the limited company as profits.
If any of this is going over your head, don’t panic. An accountant will be able to sort through this noise in no time and tell you exactly how much you can make, what you can claim back, and the best way to carry out your business in regard to IR35.
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What expenses can you claim outside IR35?
We have already talked about the 5% rule that applies if you work inside IR35 for a small business. If your client is a bigger company, there are still some areas where you can claim allowable expenses:
- Pension contributions
- Travel costs
- Professional subscriptions
- Training
- Equipment and PPE
- Home office costs
- Personal business insurance
To find out more read our article about what you can claim when inside IR35.
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