IR35 and self-employed: what you need to know

IR35 and self-employed

There is a lot of confusion about IR35 and self-employed status. Many business owners wonder what IR35 really is and whether it affects their business or not. It all boils down to understanding whether a person is deemed employed or self-employed in the eyes of HMRC. IR35 is part of the legislation that aims to control tax avoidance.

In this blog we will attempt to clarify and explain some important aspects of employment versus self-employment in order to understand what IR35 is all about.

Employed or self-employed ?

Before even embarking on the journey to understand IR35 and its implications, we should really have a clear understanding about the fundamental differences between being employed and being self-employed.

The major difference is given by the type of contract you have with another person or entity with whom you work:

  • If you have with them a contract of service, where you serve the employer, than you are an employee.
  • If you have with them a contract for services, where you invoice the other entity for services rendered by you to them, then you are self-employed.

As an employee (i.e. as someone who has a contract of service whereby you serve an employer) your taxes will be deducted by your employer through PAYE (Pay As You Earn) in the form of National Insurance and Income Tax. You will not need an accountant, because your employer has the obligation to sort out how much tax you owe and pay it to HMRC on your behalf.

As self-employed however, you have the obligation to calculate and submit your income tax return to HMRC regularly and you also have the obligation to pay to HMRC these taxes that you owe. Most self-employed individuals will employ the services of an accountant to help them with their numbers and HMRC compliance.

Other indications of self-employment are:

  • You can employ a helper or a substitute
  • You yourself decide how, when and where to work
  • You choose your work hours and invoice for the work done
  • You risk your own capital and bear the losses from work that is not up to standard
  • You provide your own equipment
  • You work for several people and organizations


IR35 and self-employment: a case study

With respect to IR35 and self-employment, where an individual would normally be classed as an employee, but actually charges for their work through an intermediary, then special rules apply. These rules are known as IR35.

To make it easier to understand, let’s try to illustrate how this works by looking into the affairs of John Smith. John is the sole shareholder of Smith Marketing Limited. His company provides marketing services to various organizations.  He has recently been approached by SmartDesigns Limited to help carry out a two-year review of their marketing strategy.

As such, John will work with a small team of SmartDesigns Limited employees and have access to the company’s IT equipment. John will also be provided with an office at SmartDesigns Limited headquarters, where he will work three days every week, leaving him free to work from home for other clients the rest of the time. John plans to invoice SmartDesigns Limited £3500 per month for his services through his company, Smith Marketing Limited. The big question is: does this qualify as employment or self-employment ?

Well, there are clear indications that the work that John does for SmartDesigns Limited is actually employment:

  • John will use an office at SmartDesigns Limited and use their IT equipment
  • John will work set days alongside other employees of SmartDesigns Limited
  • John appears to need to do the work himself and cannot provide a substitute

This is a classic example of IR35 at play. A worker, John Smith, appears to work as an employee for an organization, SmartDesigns Limited. Instead of being paid as an employee of SmartDesigns Limited, John arranges for his own company, Smith Marketing Limited, to invoice SmartDesigns Limited. John than arranges for Smith Marketing Limited to pay him either as an employee of Smith Marketing Limited or through dividends. In doing this, Joh attempts to pay much less taxes than he would as employee.

IR35 legislation was introduced to prevent this type of situation where a person disguises being employed by a company.

IR35 applications and consequences

When someone is suspected of disguising being an employee in the way we saw in the case study above, then HMRC will draw a comparison between certain aspects of the persons work in order to assess whether IR35 applies.

If indeed IR35 applies, then HMRC will compare the amount of National Insurance and Income Tax that Smith Marketing Limited pays on behalf of John Smith with the amount of National Insurance and Income Tax that SmartDesigns Limited would have paid to HMRC if John had been treated as an employee.

When the amount of National Insurance and Income Tax that Smith Marketing Limited pays on behalf of John Smith is lower than the amount of National Insurance and Income Tax that SmartDesigns Limited would have paid to HMRC if John had been treated as an employee, then the difference will form a deemed employment income tax charge (or deemed employment payment that will be levied on the intermediary, namely John’s company, Smith Marketing Limited.

By this HMRC ensures that there is no tax saving through the use of intermediaries when used to disguise employment.

Under IR35 rules, an intermediary could be:

  • A limited company in which the worker or his family controls at least 5%
  • A partnership in which the worker or his family is entitled to at least 60% of the profits

When IR35 applies to a situation, but the intermediary does not conform to the rules, penalties and interest will apply.

Now might be the ideal time to engage the services of an accountant to do all the work for you and provide you with all the tax advice you need.

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