What does IR35 mean for my business?
Businesses that engage contractors who provide their services via a service company need to make sure they comply with IR35. IR35 refers to tax legislation which aims to prevent workers from avoiding tax by working as contractors via a service company when they are really employees.
From 6 April 2021, clients will need to determine the employment status of a consultant every time they agree to a contract with a consultant or agency for services. Read this guide to find out how a consultant’s status can be determined for IR35 purposes.
IR35 is a tax law introduced to tackle tax avoidance by workers (sometimes known as 'consultants' or 'contractors') supplying their services to clients via an intermediary. An intermediary is a party who makes arrangements for or pays an individual to work for a third party who would otherwise be an employee.
Where IR35 applies, the fees paid by the client to the consultant are treated as employment income and subject to income tax and National Insurance Contributions. For more information, read IR35.
A consultant’s employment status will need to be determined every time a client agrees to a contract with a consultant or agency. To determine a consultant’s employment status, all relevant facts need to be considered and evaluated and the basic features of the relationship established. Based on the facts of the nature of the relationship, the employment status should then be determined.
To determine the employment status of a worker you should consider:
Is the consultant an office holder?
What are the terms and conditions of the engagement?
What is the nature of the job?
Is the consultant in business on their own account?
What degree of control does the client have?
Are the services provided personal services?
How is equipment provided?
Is there a financial risk for the consultant?
What is the payment basis?
Is there mutuality of obligations?
Do leave rights and benefits exist?
Is the consultant ‘part and parcel’ of the organisation?
Is there a right to terminate the contract?
What is the length of the contract?
Is the work being carried out regularly?
What are the parties’ intentions?
Are the services exclusively provided to the client?
Consider whether the consultant has been engaged as an office holder.
While there is no exact definition of what an office holder is, an office holder is an individual who holds an office. An office may be created by statute, a charter or other document which is (or forms part of) the constitution of an organisation and has specific duties attached to it.
Examples of office holders include:
the company secretary
members of the clergy
Office holders are automatically held to be employees and are always charged tax and National Insurance Contributions.
Consider the contract under which the consultant is providing the services.
The contract is a crucial factor when considering a consultant’s status as it sets out their rights and obligations. It is essential to establish and consider the full terms and conditions of the engagement in addition to any practices which exist in the trade and industry that, although not expressly agreed between the parties, still form part of the agreement.
Once all the information has been obtained, verify that the terms and conditions of engagement have been complied with by comparing what is supposed to have happened with the actual working arrangements.
Where there are differences between the contract and what happens in practice, establish the reasons for this. For example, is there a difference because:
the client and consultant agreed on a variation to the contract
a term of the contract is a sham or pretence (eg the contract states that the consultant will provide all necessary equipment, when in reality, all the expensive and specialist equipment is supplied by the client at no cost to the consultant. The client and consultant agreed that the intention was always for the client to supply all the equipment, and the equipment clause in the contract inserted to ensure self-employed status)
a particular term has not been enforced (ie the contractual term applies to the relationship, but in practice, the contract has not been followed to the letter)
Where points 1 and 2 apply, it is what happens in practice that will generally determine the consultant’s status.
Where point 3 applies, it is the contractual term that is relevant in determining the consultant’s status.
Determine if there are other workers (who are classed as employees) doing similar work under similar terms and conditions. If they are, this may indicate an employment relationship.
Examine the period leading up to the engagement of the consultant and look at whether they replaced an employee, or whether the consultant was previously an employee of the business and became self-employed without any changes to the terms of engagement. Where the latter is the case, determine why the consultant became self-employed.
Where the consultant replaced an employee, with the consultant doing similar work to the employee, this may indicate an employment relationship. Similarly, where the consultant used to be an employee before becoming self-employed, an employment relationship may be inferred where few or no changes were made to the terms of engagement.
The consultant will be in business on their own account if they set up the business alone and are solely responsible for the success or failure of the business.
If the consultant is in business on their own account, then the contract is a contract for services. If the consultant isn’t in business on their own account, then the contract is a contract of services.
Where a contract is for services, this is generally a contractor-client relationship, while a contract of services is generally indicative of an employee-employer relationship.
When investigating the consultant's status, the degree of control the client has over the consultant needs to be established. Ask yourself if the client has the right to control:
what the consultant has to do
where the consultant has to carry out the work
when the work has to be done, and
how the work has to be done
If the client controls how, when and where the consultant completes the work, an employment relationship may be inferred.
The fact that the right to control the consultant exists carries a lot of weight, even where little control is exercised in practice. For example, a manager may not closely supervise the work of an experienced or skilled worker, although the right exists. This means that where a client has the right to control the consultant and the work carried out by them, an employment relationship may be inferred, even where the client does not make use of this control.
Determine whether the services provided by the consultant are personal services. This means that the contract includes an obligation that an individual will carry out work personally, with their own hands, rather than by engaging someone else to do the work for them (ie a substitute).
The provision of personal services is an essential element of employment. If the consultant performs a task but is free to engage someone else to carry out the task or provide substantial assistance, then it is unlikely that the consultant is an employee. It is the right to appoint a substitute itself that is important, and not whether the right is used.
For the relationship to be deemed a contractor-client relationship, the consultant should have the right to decide who does the work (ie them or a substitute) and, where a substitute is appointed, the substitute should answer to and be paid by the consultant.
While the client may have the right to limit the choice of substitute, they should not have an unlimited right to veto substitutes, as this may mean that the consultant has to provide the services personally (ie that the right to appoint a substitute was not genuine).
To determine whether there is a right to appoint a substitute and whether it is genuine, consider:
whether there is a right to appoint a substitute in the original contract or a subsequent contract variation
when a substitute can be appointed
who decides when to appoint a substitute (ie the consultant or the client)
if the client restricts the use of a substitute
who hires the substitute
who pays the substitute
who is responsible for the substitute and their work
if a substitute has previously been used - if so, how often and under what circumstances
Determine who provides the necessary equipment - the client or the consultant.
If the client provides any necessary equipment, this points towards the existence of an employment relationship. Where the consultant provides essential equipment and/or items fundamental to the job, then this indicates a client-consultant relationship.
Determine the consultant’s financial risk in providing the services.
The existence of financial risk to the consultant is an indication of a client-consultant relationship. Generally, the greater the financial risk to the consultant the stronger the indication of self-employment.
Individual consultants who risk their own money (eg by buying equipment, materials and assets; paying for training to complete the work; paying for running costs; or paying for overheads) are likely to be considered self-employed, as employees typically do not need to cover these types of costs with their own money.
Determine how the consultant is paid and how often they are paid.
Generally, employees are paid a fixed wage or salary (on a weekly, monthly or yearly basis) and are entitled to additional payments like paid overtime, long service bonuses or profit shares. Consultants, on the other hand, are generally paid a fixed sum for a particular job. However, care should be taken, as there are examples of employees being paid commission or by piece of work, while there are consultants who charge by the hour or day.
The underlying method of payment should therefore also be considered important when determining the consultant’s status. For example, consider whether hourly or daily payment allows the client to exercise control over the consultant. If yes, then this points towards an employment relationship.
Consider whether there is mutuality of obligations. This is an obligation on the client to provide work to the consultant, as well as an obligation on the consultant to accept the work.
If the client is obliged to offer paid work and the consultant is obliged to accept it, this is an example of a contract of services and therefore points towards an employment relationship.
Consider whether the work is carried out under a series of separate contracts (where benefits do not accrue) or under a single ‘umbrella’ contract (where benefits may accrue). The latter is more likely to point towards an employment relationship, while the former points towards a client-consultant relationship.
Further, where work is continuously offered and accepted over a period of time, this may create a continuous contract of employment.
Consider whether the consultant is entitled to leave rights (eg sick leave and holiday) and benefits (such as pension rights and sick pay) by virtue of the agreed contract. Where leave rights and benefit entitlements exist, this may indicate an employment relationship.
When considering leave and benefit entitlements it is important to remember that their presence or absence does not itself determine the employment status of the consultant. Instead, it is the employment status itself, in addition to the contract length, which determines whether the consultant in question is entitled to many of these rights.
It is important to note that not all employees have a contractual right to paid leave (eg where employment is a short-term arrangement).
Alternatively, some consultants may be entitled to paid leave under the Working Time Regulations (ie acquiring the right to paid leave under the Regulations if they have been continuously engaged for 13 calendar weeks). This, however, is not to be taken into account when determining status. Instead, any changes to the contract giving rights to paid leave should be considered, as this may indicate an employment relationship.
As with leave entitlements, benefits (especially pension scheme membership) may be absent from short-term employment as they may be inappropriate in such circumstances. The absence of such benefits, therefore, does not immediately indicate that an employment relationship doesn’t exist. However, the existence of benefit entitlements (eg sick or maternity pay) in long-term arrangements, can be indicative of an employment relationship.
Consider whether the consultant is ‘part and parcel’ (ie an essential or integral part) of the client’s organisation. In determining this, consider whether the consultant is integral to the client’s business or whether they are merely an accessory to it.
A genuinely self-employed consultant should generally only be an accessory to the client’s business and separate from the organisation.
Factors that may indicate that the consultant is not ‘part and parcel’ of the organisation vary, but may include the consultant:
not making decisions regarding the client’s staff
not using business cards featuring their name and their client’s name
not accepting employee benefits or perks
not requesting to take holiday (instead, telling the client when they will be on holiday)
Consider whether the contract includes the right to terminate and, if so, how this can be done.
Generally, having the power to end an engagement (for reasons other than a serious contract breach) by giving notice, may be indicative of an employment relationship. However, the absence of such power of termination does not necessarily indicate a consultant-client relationship, as some employment engagements may not have the scope for dismissal by giving notice (eg employment for a specified, short time period or for the completion of the specific piece of work).
Unlike employment relationships, a consultant’s engagement (which is often for a specified time period or the completion of a particular task) can typically only be terminated for breach of contract.
Consider the length of the engagement. Note that questions regarding the length of engagement are heavily fact-dependent and vary from situation to situation.
While the length of the contract is not necessarily indicative of employment status, the longer the engagement the more likely it is to be a contract of services (ie an employment relationship). Similarly, the shorter the engagement, the less likely it is to be indicative of a contract of services.
For example, the longer the engagement, the more likely it is that:
the client will want (or require) significant control over the consultant (eg to move the consultant between tasks) - this being indicative of an employment relationship
the consultant may be to become an integral part of the client’s organisation - this being indicative of an employment relationship
The opposite can be said about short term engagements.
Consider the regularity of the work being carried out - ask yourself if the work is regularly offered and accepted over a period of time. If yes, then this may point towards the creation of a continuous contract of employment.
Similarly, ask yourself if the consultant works solely for one client and whether their contract has been renewed multiple times. Genuine self-employed consultants may generally work for multiple clients at the same time. Regular working for the same client may indicate that there is a single and continuing contract of employment, rather than a genuine relationship of self-employment.
When determining a consultant’s status you may need to consider the consultant’s and client’s intentions. You should generally do this after having gathered all relevant facts and considered the above steps - where you consider the case to be borderline, you should look at the parties’ intentions.
While the parties’ relationship (or what they consider the relationship to be) is not conclusive regarding status determination (as it is the reality of the relationship that matters), intentions must still be taken into account.
Where there is a mutual intention for the engagement to be for a contract of employment or for a contract for services, this will determine the status of the worker. Mutual intention of the parties does not need to be considered where the relationship between the parties is not ambiguous.
Consider whether there is an obligation to provide services exclusively to one client. Where this is the case, this may be indicative of an employment relationship.
However, bear in mind that exclusive services clauses are not just found in employment contracts. They may also be found in contracts with third-parties or self-employed individuals (eg someone running an agency for an insurance business may be prevented from selling any other business’ policies). Therefore, the absence of an exclusivity clause does not necessarily indicate self-employment.
Determining status based on exclusivity of services will therefore depend on the situation’s specific circumstances. However, a genuinely self-employed consultant should generally not be prevented from undertaking work for other clients.
Once the status of a consultant has been determined, this needs to be communicated to the consultant. This is done using a Status Determination Statement (SDS), which must be given to the consultant and the persons or organisations they contract with (ie an agency).
The SDS must give a conclusion on the consultant's employment status and the client's reasons for coming to that conclusion.