IR35: What does HMRC mean by a disguised employee?
If you’re new to contracting, or have been taking a bit of a break, you may not be up to date on the changes to IR35 legislation that came into effect last year.
Of course, IR35 has been around since 2000, but back in 2016, it was announced that the reforms would be made to crack down on ‘disguised employees’ in the public sector. This was eventually expanded to the private sector, with those changes set to launch in April 2020. However, the global pandemic caused the Chancellor to delay them by a year to April 2021 and contractors have been living with those changes for almost a year now. But what were those changes?
IR35: a brief overview
The IR35 legislation was originally designed to ensure self-employment wasn’t being used as a ‘disguise’ for permanent employees to save money for both the ‘employer’ and ‘employee/contractor’. Historically, the contractor was in charge of declaring their IR35 status for each of their contracts, letting HMRC know if they are ‘inside’ (effectively an employee) or ‘outside’ (genuinely self-employed) IR35 as part of their Self Assessment. The contractor also held the tax liability. However, the reforms to the legislation have changed how this works.
As of April 2021, it is usually the end-client who is responsible for determining a contractor’s IR35 status. They do this by producing a Status Determination Statement (SDS) which declares a contractor either inside or outside IR35 for that particular engagement. This is then passed down the contractor supply chain to the fee payer (if the fee payer is not the end-client). It is the fee payer (this might be a recruiter, agency or the end-client themselves) who hold the liability for tax, and who is responsible for deducting tax and National Insurance through PAYE if the contractor is deemed to be inside IR35.
If a contractor is found to be inside IR35, they are taxed at source and at the same rates as an employee. If the contractor is outside IR35, they continue to be responsible for their own tax and National Insurance through Self Assessment.
What is a disguised employee?
A disguised employee is a contractor who, to all intents and purposes, fulfils the same role as a permanent employee, but is hired as a contractor and paid through their limited company. This means that the contractor gets a more generous tax rate, while the end-client doesn’t have to pay for employers’ NICs, insurance, or any other administrative costs of hiring an employee. Ultimately, this approach sees HMRC lose out, so IR35 aims to tackle it.
To determine whether or not you are a disguised employee, you and your end-client should be looking at elements such as:
- Control: do you have control over your workload or does your client manage it in the same way they would manage an employee?
- Personal service: does the work have to be carried out by you or do you have a right to send a qualified substitute to carry out work in your place?
- Mutuality of obligation (MOO): is there an expectation for the client to continue to offer work, and an obligation for the contractor to accept it?
- Part and parcel of the organisation: More generally is the contractor a core part of the client’s team or are they a separate entity? There are several tests for this.
These are the same issues that HMRC would look at if they were carrying out an IR35 investigation into your contract and so they should also be used to determine your status. If you do not have control, cannot send a substitute, or you are expected to continue accepting work from the client, you could well be deemed a disguised employee. We recommend using a service such as the Kingsbridge IR35 Status Tool to accurately determine your IR35 status so that you can see the strengths and weaknesses of your case.
When is a contractor still responsible for their IR35 status?
The legislation reforms have not changed IR35 for all contractors. There are still some cases in which you as the contractor are responsible for determining your own IR35 status (and still hold on to any tax liability). These include:
- If your client is a small business. The legislative reforms only apply to medium and large organisations. A client’s business can be considered small if at least two of the below criteria are satisfied:
- An annual turnover of less than £10.2 million;
- Less than £5.1 million on the balance sheet;
- No more than 50 employees on average during the tax year.
- If your client is based overseas. There are a lot of variables in this instance, but if your client is based overseas and has no UK branches (no matter how small) whatsoever then IR35 does not apply.
- If you, the contractor, work overseas. If you are classed as a non-UK resident and are working abroad, then you do not have to consider IR35 at all.
You can read more about when a contractor is and isn’t responsible for IR35, including all of the variables, on our Knowledge Hub.