The IR35 legislation was introduced by HMRC (Her Majesty’s Revenue and Customs) in April 2000 and was intended to combat tax avoidance. It affects all contractors who do not meet HMRC’s definition of ‘self-employment’ and applies to anyone working via an intermediary such as a company or partnership. Over time, since the introduction of the legislation, tests have been developed from the results of legal cases which indicate whether or not an individual’s working practices are likely to fall inside or outside of IR35.
These tests are used to determine whether, if it were not for the intermediary, the contractor would be an employee of the end client. The contract must be totally representative of the individual’s working practices and would fail the IR35 ‘test’ if this is not the case. Your IR35 status determines the way that your earnings must be processed; if you fall inside IR35 your earnings are subject to PAYE and so deductions must be made for income tax and national insurance contributions. If you are outside IR35 and you operate through your own Limited Company and not an intermediary, you can draw dividends from the company which do not attract national insurance contributions.
In May 2012, HMRC released an update to the original tests, this time looking at a risk based approach.
Extract from Intermediaries Legislation (IR35):
We will consider how likely it is that we need to check whether IR35 applies to you. To gauge how likely it is that we need to check whether IR35 applies to you, we will look at how your business works. We will use three risk bands:
- low risk
- medium risk
- high risk
‘Low risk’ means that there is a low risk that we will check whether IR35 applies to you.
‘Medium risk’ means there is a medium risk that we will check whether IR35 applies to you. There are some pointers that IR35 applies, but there are some pointers that it does not.
‘High risk’ means that you are more likely to have an IR35 review than those in the ‘medium risk’ band. There are likely to be several pointers that IR35 applies to you.
These risk bands are bands on a spectrum, not pigeonholes. If we think that IR35 may apply to you, we will write to you and ask you whether you have thought about IR35. If you tell us that you think you are outside IR35, we will ask you for evidence.
Click here to Determine your IR35 Status.