Contractors are wrongly losing 30pc of their pay – find out if you’ve been caught by IR35

If you are a freelancer, then you are at risk of falling into one of HM Revenue & Customs’ (HMRC) most complex and hated tax traps. 

The “off-payroll working” rules, or IR35, mean that a worker using an intermediary, such as a limited company, must have their employment status assessed for tax purposes. 

Several highly paid broadcasters, including Gary Lineker and Adrian Chiles, faced their own battles with the tax man over the rules. They were victorious but Loose Women’s Kaye Adams is still being pursued after HMRC appealed against a ruling made in her favour three years ago. 

Former chancellor Gordon Brown introduced the legislation in 1999 to tackle “disguised employment” – where workers effectively act as employees but are taxed as contractors. This can save large sums for both the contractors and the companies that pay them. 

Liz Truss and Kwasi Kwarteng used their ill-fated 2022 mini-Budget to announce that the rules would be repealed but they weren’t in power long enough to see it through.

Mike Warburton, a former tax director at Grant Thornton and Telegraph Money columnist, said: “When the rules were introduced, there were many people working in the IT industry in particular who would leave work on Friday as John Smith and return the next Monday as John Smith Ltd performing exactly the same role but paying less tax and National Insurance.”

But the rules have opened up a world of complexity. Taxpayers have been subject to lengthy investigations by HMRC, some of which have ended up in court, to determine whether they are inside or outside IR35, with the self-employed sometimes having to settle huge tax bills years later.

In other cases, it has transpired that the worker was not in fact in breach of IR35 legislation – meaning they were pursued for years when they had done nothing wrong. The average IR35 enquiry drags on for two years until a verdict is reached, according to data from contractor insurance provider Qdos. 

Mr Warburton said the rules are a “blight on contractors”. 

He said: “Unfortunately, Gordon Brown did not take the opportunity to define what was meant by employment. He left that to the courts who, in a series of complex and contradictory rulings in the last 23 years, have left a complete mess.”  

There are concerns that employers – fearful of the consequences of getting it wrong – may err on the side of caution and incorrectly place contractors inside IR35. In some cases, they simply refuse to hire contractors at all, for fear of categorising them wrongly. 

Seb Maley, of Qdos, said: “Given contractors who are wrongly placed inside IR35 can expect to take anything up to 30pc less home after tax, it’s vital that contracts that genuinely belong outside IR35 are deemed outside IR35.”

The Government’s own tool, “check employment status for tax” – was plagued with problems. In 2018 it was found to come to the wrong conclusion in nearly half of cases, leaving freelancers to run the gauntlet themselves, and take the risk that they had got it wrong. At the time, HMRC said its tool had been “rigorously tested” against “known case law and settled cases”.

Here, Telegraph Money, with help from Qdos, explains how to assess how likely you are to fall inside the rules.

What does it mean to be inside or outside IR35?

If you are inside IR35, this means HMRC does not consider you self-employed. It considers you an employee of your client and you will therefore be subject to the Pay As You Earn (PAYE) system, where your income is taxed at source.

If you are outside IR35, then HMRC considers you self-employed. This means no income tax and NICs will be deducted at source when you are paid and you must instead pay tax via self-assessment. 

Is it good to be inside or outside IR35? 

Being inside IR35 has a direct impact on a contractor’s take home earnings. Contractors may receive up to 30pc less in their pay packet because they are taxed at source. 

Another criticism of the IR35 system is that those placed within it are taxed as employees despite not enjoying the other benefits of being on the payroll, such as sick leave, employer pension contributions and holidays. 

Who decides if you are in or outside IR35? 

It used to be the case that contractors would assess their own employment status. However, after finding that “only 10pc” of contractors who owned their own company were applying the IR35 rules correctly, HMRC shifted the burden of assessment from workers onto hiring bodies. 

These reforms applied first to the public sector in 2017 and were then extended to medium and large private companies in 2021. 

HMRC estimates that 250,000 workers have moved from being on their own payroll to an employer’s payroll between 2019 and 2022.

But the influential Public Accounts Committee said in a 2022 report that there are issues with leaving the assessment up to employers.

It said: “Hiring organisations cannot always get all the information needed to accurately assess a worker’s status, and it is too difficult for workers to challenge incorrect determinations as there is no independent appeals process.”

Mr Maley said: “After the rollout of IR35 reform, unless a contractor is engaged by a ‘small business’, the end-client is responsible for determining IR35 status.

“But with a basic understanding of what it means to be inside or outside IR35, contractors will be better placed to negotiate contracts that belong outside IR35 and challenge inaccurate decisions made by clients.”

Am I inside or outside IR35?

Working out whether you are inside or outside IR35 is difficult. HMRC introduced a “Check Employment Status for Tax” tool to help contractors determine their status. However, in one in five cases, it cannot reach a decision either way. 

The Telegraph asked Qdos for a list of questions that could help contractors work out where they are placed.

If you mostly answer positives to the below, then it is likely you are operating outside IR35. If most of your answers are negatives, you are probably within the scope of the legislation. 

However, it is not possible to be definitive. The below is only a guide. 

Mr Maley said: “With so many factors to consider before deciding if a contractor belongs inside or outside the rules, deciding IR35 status is rarely black or white.”

Does your end client dictate how you carry out your services?

• Positive – No – You’re the expert brought in to carry out the services which is a positive indicator of self-employment. A contractor engaged for their specialist skills and experience shouldn’t be controlled over their method of work.
• Negative – Yes – It’s perfectly fine for the client to set out the parameters of the engagement, so start at point A and get to point B. But how you get from point A to point B should be down to your expertise. If your client has the right to control your method of work, this will point towards an employment relationship.

Does your client provide or pay for training that boosts your own personal skill set?

• Positive – No – Paying for your own training and qualifications helps show that you’re an employee of your own company, rather than of your end client.
• Negative – Yes – If the end client is paying to enhance your own skills or qualifications, this could be seen as an employment benefit. As a contractor, your own company should be responsible for keeping your skill set and qualifications up to date. 

If your work wasn’t up to standard, would your limited company rectify any mistakes at your own cost?

• Positive – Yes – Being financially liable for correcting faulty work shows that you take a financial risk; an indication of operating a genuine business. The stronger the financial risk is, the greater the evidence towards genuine self-employment.
• Negative – No – This is generally hypothetical but, as an independent contractor, you should be expected to rectify any defects or shortcomings in the services you provide at your own time and cost.

Is there any obligation (written, implied or otherwise) for your end client to provide you with further work after the contract term has ended?

• Positive – No – Once the contract has ended, there should be no expectation for further work, nor should there be any expectation for you to accept any offers of work. If you were an employee, continuous work would be provided to you, and you would be obliged to carry out the additional work.
• Negative – Yes – A continued expectation for the contract to be extended demonstrates an employment relationship. If the contract is extended because the work isn’t complete for reasons outside your control then this is acceptable, but if you have finished the project early, for example, that should be the end of the engagement and further work shouldn’t be expected. 

If you were personally unable to provide the services, would the client accept another person on behalf of your company to undertake the services, provided they were suitably skilled and qualified?

• Positive – Yes – The ability to send substitute personnel on behalf of your company is a strong indicator of operating as a genuine business and is one of the most crucial IR35 status tests. Exercising your right of substitution, even for one day, would significantly strengthen your case in an enquiry.
• Negative – No – It’s important to remember that the contract is with your company and not you personally. A genuine business should be able to deliver the services using suitable representatives of its choosing and provide alternative personnel, if necessary, to cover periods of illness or holidays for example.

Does your contract specify an end date?

• Positive – Yes – Having a clearly defined start and end date to the contract suggests that you’ve been engaged for a specific project with clear deliverables. A rolling or ongoing contract is akin to employment and should be avoided where possible.
• Negative – No – Ideally there should be an end date to the contract as continuous contracts can indicate employment.

Can your client move you to a different task or project that wasn’t originally contracted?

• Positive – No – Being moved from task to task would be considered a feature of employment. As an independent contractor, you have been engaged to provide very specific services and therefore cannot be moved from job-to-job like an employee.
• Negative – Yes – You should be engaged to provide very specific services and therefore the client shouldn’t be able to move you from job to job as their priorities change. Any material changes should be treated with a separate contract for services.

Does your client dictate your working hours?

• Positive – No – You have control over when you provide the services which is a positive indicator of self-employment.
• Negative – Yes – You should have the flexibility to deliver your services within working hours that enable successful delivery of your services, while having to abide by the same hours as your client’s employees could imply that you’re treated as one. If you’re working set hours due to specific requirements, such as client opening times, then this would however be seen as reasonable.

Are you easily identifiable as an external contractor within your client’s organisation?

• Positive – Yes – Being provided with an ID badge or email signature which identifies you as a contractor or visitor helps highlight that you’re an external supplier and not seen as part of the business.
• Negative – No – If you appear as an employee of your client, this could suggest that the client doesn’t recognise you as an independent contractor. It’s crucial from an IR35 perspective to ensure your client recognises that you are not an employee and that you are treated as such.

Do you carry business insurance such as professional indemnity or public and employers’ liability insurance?

• Positive – Yes – Holding business insurance is a good indicator of being in business on your own account. Most contracts will stipulate a requirement that you hold such policies, so for a relatively small outlay it’s always advisable.
• Negative – No – If HMRC opened an enquiry and discovered that you operated without insurance while it was required in your contract, they could proceed to challenge the authenticity and effectiveness of other contractual clauses. If your client instead provides insurances that cover your business, then this could be seen as receiving an employment benefit.

Have you been caught out by IR35? We want to hear from you, email money@telegraph.co.uk