IR35, the 'contractor tax', demystified

Contractors and freelancers who choose not to be permanent employees and work flexibly for many clients have been targeted by UK tax legislation called IR35.

IR35 tax legislation is designed to tax as if they were 'disguised employees' workers providing their skilled and predominantly knowledge-based services to clients via their own limited company. IR35 can result in these workers losing up to 25% of their normal take-home pay in extra taxation.

Unfortunately, IR35 was poorly thought through and subsequent tax tribunals and court cases have made things so complex that prudent contractors pay professional advisers to ensure they are not caught by IR35.

Her Majesty's Revenue and Customs (HMRC) mounts IR35 investigations into many contractors' tax affairs every year, and is able to investigate contractors' tax returns and working practices up to six years in arrears. And many contractors end up in IR35 tax tribunals or court cases because they dispute having to pay the extra tax demanded.

When deciding on whether or not a contractor is inside IR35 and therefore must pay extra tax, HMRC inspectors - and later tax tribunals and courts - look at three key areas:

- The written contract between the contractor and the agency and end-user client

- The contractor's business as a whole

- The actual working relationship between the contractor and their client.

What tax inspectors want to prove is that the contractor is really a 'disguised employee', and if the contractor did not have an intermediary like their limited company between them and the client, they would be a permanent employee and should be taxed as such. This is why IR35 is also called the 'Intermediary's Legislation'.

HMRC uses key 'tests of employment' to check if a contractor is a disguised employee, including:

- Whether the contractor is controlled, or told how to work, by their end user client

- The ability of the contractor to use a substitute on the contract - Mutuality of obligation, or 'MOO'

- where an employer is obliged to provide work and an employee is obliged to do it.

Generally, if a contractor fails one of these tests, a tribunal or court will find that they are outside of IR35 and so do not have to pay extra tax as an employee. Unfortunately, though, tests of employment are rarely straightforward. So contractors can undergo long periods of stress during the course of an IR35 investigation, and still fall foul of IR35 legislation due to technicalities.

There are easy actions contractors should employ to reduce the chances of them being found within IR35, eg to invest in tax investigation insurance, to get contracts checked by an expert, and to get clients to confirm the contractor's working arrangements.

Contractor organisations have tried to abolish IR35 for many years, but it is likely that the legislation, or something very similar to IR35, will remain on the statue books for the foreseeable future. Therefore, contractors should always ensure they manage their contracting careers so that they never fall foul of IR35.


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Dave Chaplin was an IT contractor in the City and knows what it takes to carve out a successful contracting career. He has turned all his experiences and those of dozens of contractor experts into a fantastic resource of how-to guides, advice and detailed contractor information, including loads of guidance about IR35, which you can download free from www.contractorcalculator.co.uk