Hiring global talent requires understanding applicable worker classification laws, so you can hire cost-effectively and avoid non-compliance penalties. When hiring in the UK, you must pay special attention to IR35 rules and correctly classify employees and independent contractors per the latest requirements. In this post, you’ll learn everything you need to know about IR35 and how to keep your business in compliance.
What is IR35?
IR35, or Inland Revenue 35, named for the reference number of the press release that announced it, is UK tax legislation. The law is designed to prevent employees from being classified as independent contractors and paying less tax than they would under a traditional employee-employer relationship. It is enforced by the UK’s tax collection body, His Majesty's Revenue and Customs, or HMRC.
Before the legislation was enacted in 2000, contractors could easily establish a limited company structure, also called a personal service company (PSC), that would significantly reduce the tax burden on their earned income. By working under a PSC instead of being an employee, individuals could take their earnings as dividends, which are taxed at a lower rate than employment income tax.
IR35 and its subsequent reforms make it harder for contractors to reduce their tax liability through PSCs. As a result, many UK contractors pay the same income tax rate as regular employees. In a 2021 Association for Independent Professionals and the Self Employed (IPSE) survey, 36% of UK freelancers said their current working engagements were subject to IR35 rules.
“Inside” vs. “Outside”
For any employer working with UK contingent workers, it’s essential to classify individuals as either “inside IR35” (providing services that are deemed employment) or “outside IR35” (working on a self-employed basis and not subject to IR35 requirements). This classification not only determines the tax rate contractors must pay, but also whether their clients must make national insurance payments on their behalf.
HMRC considers three main factors in determining a contractor’s inside or outside IR35 status:
- Right of Substitution: Contractors are considered inside IR35 if they cannot use a substitute to perform client work on their behalf.
- Control: Contractors are considered inside IR35 if they have limited or no control over their workload, how they work, or where.
- Mutuality of obligation: Contractors are considered inside IR35 if they have a shared obligation with their client (the client is required to provide the work, and the contractor must complete it).
Secondary factors can also impact classification, such as whether contractors use their own equipment or receive company benefits.
Recent rule change
Though IR35 was established in 2000, it has undergone several updates and reforms, most recently in 2021. Before 2021, contractors working in the private sector were solely responsible for proving they were not inside IR35. Under the new IR35 rules, the responsibility has shifted to employers (small businesses are exempt), who must now determine whether or not their UK contractors are inside or outside IR35. For any contractors found by HMRC to be inside IR35, the employer must deduct national insurance payments and taxes from the contractor’s pay and pay the employer portion of national insurance.
Tips for Complying With IR35 Rules
Employers who misclassify their UK contractors’ IR35 status or fail to make the correct deductions and payments for taxes and national insurance can face hefty HMRC penalties. And even if your organization hasn’t been fined for non-compliance, it can still be a target for an IR35 audit.
To ensure your organization hires UK contractors in compliance with IR35 rules and can successfully withstand a potential audit, be sure to take the following steps:
1. Know whether IR35 applies to your business
Not all organizations are subject to IR35 requirements. However, if your organization has a UK presence and meets two or more of the following criteria, then it is not considered an exempt small business by HMRC, and IR35 rules apply:
- Business turnover exceeds £10.2 million
- Balance sheet total exceeds £5.1 million
- More than 50 employees
2. Correctly classify all UK contractors
Since employers and agencies must properly classify UK contractors, it’s essential to have a consistent and reliable process for making those classifications. Though HMRC provides a Check Employment Status for Tax (CEST) tool, it has been criticized for misleading and inaccurate assessments.
Instead of relying on slow and outdated resources, implementing an IR35 compliance solution can help you correctly classify UK contractors and limit your compliance risk. Worksome’s IR35 compliance solution simplifies IR35 management by connecting your organization with recruiters and contingent workers in one integrated platform. With the solution, you can:
- Contract UK external workers and determine their IR35 classification in minutes.
- Minimize IR35 risk with fully insured Status Determination Statements attached to all contractor engagements.
- Ensure timely and accurate payments to all contractors and freelancers, whether they are inside or outside IR35.
3. Stay on top of future legislative changes
The 2021 IR35 reforms aren’t likely to be the last. In addition to possible upgrades to the CEST tool, other changes may be coming. In April 2023, HMRC released a consultation document regarding a potential change that would make contractors and employers share responsibility for determining IR35 worker classifications. Given the potential for ongoing legislative changes, having a global compliance partner who can help you keep your IR35 activities aligned with the latest rules is critical.
IR35 certainly brings some complexities for global employers, and the challenges can quickly multiply as you engage more contractors to help you fill critical skill gaps. Worksome’s contingent workforce management platform can take the pain out of IR35 compliance and help you hire contractors in line with applicable requirements. Book a demo to see for yourself the UK’s first end-to-end IR35 solution for employers.