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The Potted Guide to IR35

This is not and does not claim to be a definitive guide to IR35 and how to avoid its clutches. That is something that has defeated many experts over the last ten years. However, I hope to provide a summary of what we do know about IR35, what all the arcane acronyms really mean, and which bits are the important ones.

There is a lot of detailed discussion out there; too much to be easily read these days. Much of it has been written by people with their own agenda which is why some advice seems to conflict with other versions. So I thought a simple and pragmatic overview from an informed freelancer's side is probably overdue.

IR35, or the "Intermediaries Legislation" as it is more properly called, was announced in the Budget of 1999 and came into force in April 2000. Its aim was to stop people using dividend payments instead of salary in order to avoid paying a large percentage of their National Insurance contributions. It didn't try to make that practice illegal, since that would be rather difficult, but it attempted to define a set of conditions that would make you pay those "missing" NI contributions.

Its real genius was to fail to define what those conditions are. Instead it said that if you look like an employee, you will pay tax as an employee on all your earnings, except we'll give you 5% to cover your working costs since you are not an employee. You can see why there might be a degree of confusion.

The definition of an employee has been set by case law over many years. At its simplest, it comes down to three key concepts: Direction and Control, Mutuality of Obligation and Right of Substitution. Each needs to be defined in the contract and, obviously, the contract has to match reality pretty closely if it is to stand up in court.

Direction and Control means that the client can tell you what to do. If however, he can tell you to do things that are not directly relevant to delivering what it is you are there to do, then that is excessive. A quick check is "Do the permanent staff have to do this to do the job?" If they do, then fine, if not it is excessive. This needs to be managed with a degree of care and sympathy, of course: no point staying outside the client's rules on hours of work and then simply not turning up because you fancy a day off. Equally, most freelancers are given an objective, a set of quality constraints and a time scale; those are not Direction and Control, since you are free to deliver the objective in the best way you see fit.

Mutuality is a bit complex but at its simplest, does the client have to offer you work, do you have to accept it if offered, and can you charge when there is no work to do. There will be an irreducible minimum of Mutuality in any contract, but for our purposes the simple maxim of "No work, no pay" will work as the basic key test.

Right of Substitution is fairly clear cut: can you send someone else to do the work. Employees can't do that, so if you can, you are not an employee. However, the client has to have some say in the matter. The usual formula is along the lines of "you may send a substitute subject to the approval of the client, such approval not to be unreasonably withheld".

Any one of the above should be enough to take you outside IR35, but the ideal would be all three. And let's be clear, the above three conditions genuinely have to exist in reality as well as in the contract. A case (Dragonfly) was lost recently in part because the client denied they would ever accept a substitute for the worker, despite there being a clear clause in the contract that substitution was possible (a clause that was added some time after the engagement began, incidentally).

There are some other myths around IR35 that may be worth noting. Using your own kit is good, but if you have to use the client's kit, it's not that much of an issue. Having to work on site is not an issue if you have to be able to interact with other workers to do the job (although exactly when you are on site is up to you, as we have said earlier). Having multiple contracts is not a defence, since IR35 is applied on a per contract basis. Multiple clients may show you are genuinely in business but that seems not to be a major criterion in determining IR35 status despite, it being said very clearly that people in business on their own account would be outside the rules (Dawn Primarola, Paymaster General in 2000, is on record as having said precisely that).

Incidentally, Umbrella users are not and cannot be subject to IR35. They are employees in law and pay employee's taxes (as well as employer's taxes, come to that) so are out of scope.

The real trick is to think like an independent business, not as a temporary employee of the client. If you look at the engagement on those terms, much of the distinction between inside and outside IR35 becomes, if not clear, at least a little clearer.

Finally, if you lose an IR35 case it does not currently mean that you are therefore an employee. The tests they use to determine status are the same but it's only about taxation, not rights of employment. One day someone may press the nuclear button and claim employee rights because IR35 says they are one, but that hasn't happened yet.

Losing a case means all relevant tax declarations, personal and corporate, will need to be recalculated and the balances paid over, with interest. As long as you have tried to determine your IR35 status, penalties will not be applied: that is about the only good thing about the whole sorry mess.

And to close, let me offer the comforting thought that the vast majority - well over 98% - of IR35 cases challenged in court to date have found in favour of the freelance being outside.

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Alan Watts
Freelance Consultant and Interim Manager

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