Every contractor who runs their own limited company needs to be aware of the punishing and controversial legislation known as IR35.
If you put your head in the sand then you could kiss goodbye to not only up to 20% of your income after taxes, should HMRC investigate you, but penalties of up to 70% on unpaid taxes could also be charged.
Key steps to pass the IR35 rules
The key to getting your IR35 position solid is to manage the risk before signing any new contract, and then to ensure that you maintain a compliance file during the contract so that you have clear evidence of your status in the event of a future investigation.
The main steps for getting your contract to pass the IR35 rules are:
- Evaluate the status yourself
- Get the contract reviewed by an expert
- Negotiate changes with the client
- Get a confirmation of arrangements letter signed
- Adopting correct working practices during the contract
- Keep a compliance file backing up your decision
Step 1: How to evaluate your own IR35 status
IR35 is a very complex topic and requires understanding of decades of employment case law. Tax experts and HMRC inspectors themselves have different interpretations of the case law.
Contrary to common sense, determining employment status isn't a simple process of answering Yes/No to say 10 questions on one page of A4.
Employment status involves a careful examination of working practices to establish if there is sufficient evidence to consider the relationship one more akin to employment or of one closer to a business to business relationship. Judges spend hours in tribunals examining such cases.
Fortunately, at ContractorCalculator we have built an online test consisting of over 50 questions that will enable you to get an accurate judgement as to where you sit on the employment status spectrum.
There are some factors that will cast you securely outside of IR35, and others that will point directly to employment. As for the rest, it is a case of weighing all the factors up according to how much weight has been attributed to them over years of case law.
You can take this test yourself. See online IR35 status test.
If the test indicates a strong fail then you may decide, after further research, that you might be able to make changes to your contract and working arrangements with your client so that your contract is outside IR35 and passes the test. If this is the case then we would recommend you get an expert to help you.
Step 2: Get your contract reviewed by an expert
To begin, read our guide on the key factors that determine if your contract passes IR35.
You may then decide that you are in a position whereby you could change your contract and agree those changes with your client. If this is the case then it would be worth engaging an IR35 expert to review your contract in much more in depth detail. They will also try to negotiate changes on your behalf with your client.
There will be a fee for this review, and there are no guarantees of success, but compared to the extra tax you will have to pay, the fees are small.
See our guide: Getting your contract reviewed for IR35.
If the contract review reveals a 'fail IR35' you need to start taking measures to change your contract to one that reflects your outside IR35 status - if that is indeed the case.
Step 3: Negotiating changes
Your contract will need to accurately reflect your working arrangement with the client. Passing IR35 is not a paper exercise though. If the contract does not reflect working practices correctly it will be considered a sham by HMRC and the courts and will not protect you.
The most effective approach is for either you or your expert to approach the agency to negotiate your contract for IR35 compliance.
And the most realistic way is to succeed is to suggest the terms you wish to have changed in your existing contract.
Step 4: Letter of confirmation of arrangements
If the client has agreed to the changes then you will be in a stronger position. But sometimes the client may agree in principle that the contract does not reflect the true arrangement, but for operational reasons will not be able to agree to the contract itself being changed.
Either way, it is advantageous to get a client to sign a written document confirming the arrangements. This will go into much more detail than any contract, and will provide an excellent defence should HMRC come knocking at a later date.
Your expert will be able to help you draft one of these for your client to sign.
Step 5: Align working practices with your contract
If you have the paperwork in place then it is important to make sure that you carry out the work according to the contract. There's no point proving a lack of control on paper for example, if you then let the client push you around from task-to-task like a tail-end Charlie.
So, ensure your working practices are right so that you conduct yourself like a proper business and that your working practices adhere to the contract document and any confirmation of arrangements.
Avoid becoming 'part and parcel' of the organisation by distinguishing yourself as an independent consultant.
If your working practices fail to adhere to the contract, and you appear to be part of the corporate furniture then the contract will be deemed sham and ignored by HMRC and in any court tribunal.
Step 6: Keep an IR35 compliance file
It is advisable to keep a file detailing all the activities and paperwork to back up any 'outside IR35' decisions you have made.
HMRC can chase you up to 6 years later, so it is important to have a history proving that you took 'reasonable steps' to reach your decision. Failure to do so could result in large penalties if HMRC win a dispute against your decision.
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At the time of writing (Dec 2016) there are big changes happening to IR35 in the public sector. These are expected to be rolled out to the private sector in due course, because HMRC is chasing a further £420m in perceived tax losses due to IR35.