IR35 tax legislation is designed to reduce tax avoidance by freelancers who are believed to be “disguised employees”. This is the term given to those working seemingly like regular employees but charging their services through a personal service company (PSC) to be as tax efficient as possible.
IR35 provides a set of rules for organisations to determine if freelancers are “disguised employees” or genuine freelancers. Key elements to be recognised as an actual freelancer include:
If freelancers follow at least one of these guidelines, they will be able to justify that they truly work as freelancers and not as “disguised employees”, and thus pay lower taxes.
IR35 came into force throughout the UK in 2000, and currently, freelancers have the responsibility of identifying whether their contracts fall under IR35 according to the criteria provided above by HMRC. They classify themselves either as freelancers or as doing employee-like work, which will determine the amount of tax that they pay.
The new 2020 IR35 shifts the responsibility of the assessment to the organisation employing freelancers, which will be responsible for paying the related tax and NIC to HMRC.
If freelancers follow the set of rules given by HMRC and truly do freelance work, they are considered outside of IR35 tax legislation and will subsequently pay PSC taxes which are different than employees' taxes.
If freelancers are identified as employee-like because they cannot be substituted easily, they are not in the organisation for a specific purpose, or they have very little influence on their work, their contract will be considered inside IR35, and they will pay tax as if they were an employee.
In past years, several organisations were caught employing freelancers through PSCs rather than as permanent employees to reduce their tax liability. You may have heard about the famous case of Christa Ackroyd, former BBC presenter who was accused by HMRC of being a disguised employee, and liable for a tax bill of more than £400,000.
If you are a freelancer that is found working under employee-like conditions according to the criteria set by HMRC, you will be identified as working inside IR35. You will have to pay extra income tax and NIC as if you were employed. The impact is significant, as the changing tax treatment could reduce your income by up to 25%.
HMRC introduced tough penalties in case of inaccuracies, for example, if freelancers deliberately don’t make the deemed payment while knowing they are working inside IR35, the penalties can go up to 100% of the unpaid tax.
IR35 applies on a per-contract basis, which means that the particularities of each contract would need to be verified to determine if freelancers do employee-like work or not.
IR35 doesn’t prevent you from cumulating contracts for different clients. You can simultaneously have contracts that are outside IR35 - when working in freelance conditions, and inside IR35 - when doing employee-like work. You will just pay a different amount of tax on each contract.
HMRC provides a set of rules to help you know if your contract is inside or outside IR35.
Check out the HMRC website to find more information about it.