The state of IR35 in 2023: A guide for freelancers and SMEs
As part of the UK Finance Act of 2000, IR35 has been an element of UK law for over two decades, but there still remains some confusion around the implementation of the rule for both SMEs and freelancers in recent years.
A survey by Brookson Legal found that just 56% of businesses understood the government’s proposed 70/30 mix of on and off-payroll workers in their engaged personnel, a key test if a company is compliant.
Much of this confusion stems from various proposed changes to the legislation that have either come to fruition, or been scrapped by the government over the past five or six years. Indeed, the plans to possibly reform off-payroll working rules were once again cancelled by the Chancellor Jeremy Hunt in his autumn mini-budget of November 2022. Freelancers and SMEs alike are looking for clarity.
This article will explain the current state of play for both organisations, and the self-employed workers conducting work on their behalf. We’ll answer the following questions:
- What is IR35?
- What is HMRC’s definition of self-employment?
- What are the status indicators of IR35?
- What does ‘inside IR 35’ and ‘outside IR35’ mean?
- What are the punishments for failing IR35 regulations?
What is IR35?
IR35 or ‘off-payroll working rules’ is a regulation designed to ensure freelancers or sole traders pay roughly the same proportion of tax as employed workers.
Without this legislation, freelancers in theory could carry out work for multiple businesses, and have their national insurance and income tax burden lessened.
According to the Government website, you may be affected if you are:
- a worker who provides their services through their own intermediary to a client
- a client who receives services from a worker through their intermediary
- an agency or other supplier providing workers’ services through their intermediary
A worker affected by these rules may offer their work through:
- A personal services company, in most cases a limited company the worker either has control or a stake in
- A partnership
- An individual
For example, a freelancer operating as a sole trader is still considered to be affected by IR35 legislation.
The ‘client’, or the business that is commissioning and subsequently paying for the work, must decide the status of the party conducting the work. It is therefore crucial for the business to take steps to show the work carried out being conducted by someone that meets HMRC’s test for self-employment.
We recommend visiting the Government website page on IR35 or off-payroll working, and the various definitions of employment status to get the full picture.
What is HMRC’s definition of self-employment?
HMRC considers workers that meet all, or the majority of the following criteria as being self-employed:
- They put in bids or give quotes in order to obtain work
- They have more than one client
- They aren’t under direct supervision while they carry out their work
- They submit invoices for work carried out
- They’re responsible for their own national insurance and income tax
- They don’t receive holiday or sick pay when they aren’t working
- They operate under a contract that clearly stipulates the above conditions, that uses terms such as ‘self-employed’, ‘consultant’ or ‘contractor’
What are the status indicators of IR35?
These tests are then applied to a working relationship by HMRC to ascertain the reality of a working arrangement. These fall under three main ‘status indicators’:
- Right of substitution – A contractor is allowed to supply an adequate replacement to carry out the services agreed under a contract. A common application of this principle might be a marketing consultant that has agreed the delivery of four blog posts a month, which is then sub-contracted to a freelance writer
- Mutality of obligations – In an employee/employer relationship, there is a mutual obligation to carry out the work stipulated in a contract of employment. A freelance agreement will instead have a break clause, or an agreed process under which a working relationship can be terminated
- Control – Is the party carrying out the work truly independent from the client? This can be determined by working patterns. Did the party in question use company equipment, and clock in every day? Or did they work using their own premises or working schedule
What does ‘inside IR35’ and ‘outside IR35’ mean?
If you are deemed to be ‘inside IR35’ it means HMRC doesn’t consider you to be a freelancer. You are deemed to be an employee of the business, and should therefore be subject to PAYE.
Conversely, those considered ‘outside IR35’ are deemed to be self-employed, and are therefore expected to be paid in gross by the client, and subsequently pay their own National Insurance and income tax contributions.
What are the punishments for failing IR35 regulations?
The potential penalties for improper IR35 reporting apply both to the freelancer, and the client commissioning the work. As of April 2022 the penalties are as follows:
- 30% of unpaid tax if you were unaware that you had incorrectly reported your employment status
- 70% of unpaid tax if you were aware of incorrect reporting but chose not to act/report
- 100% of unpaid if you are found to actively conceal your IR35 status
Staying on the right side of this confusing law can mean the difference between a freelancer or business thriving or failing. It’s always advisable to seek the advice of a tax professional, and possibly outsource your accounting function to stay compliant.
Are you an SME, or freelancer that wants to avoid such harsh penalties? Get in touch with Pennyhills today to make sure you stay compliant with IR35.