Madison Genthry 
The IR35 legislation, first introduced by HM Revenue and Customs (HMRC) in the UK, plays a significant role for contractors, freelancers, and businesses alike. The IR35 rules are designed to identify whether contractors are genuinely self-employed or effectively operating as employees through an intermediary, such as a limited company. Understanding the IR35 assessment process is essential to ensure compliance, avoid unnecessary tax penalties, and establish clear working relationships.
This guide explains what IR35 is, why it matters, and how the IR35 assessment process works. By understanding the basics of IR35, both contractors and businesses can take steps to ensure they are operating within the law.
What Is IR35, and Why Does It Matter?
IR35, also known as the “off-payroll working rules,” is tax legislation aimed at preventing “disguised employment.” Disguised employment occurs when a contractor or freelancer works in a way that is essentially the same as a full-time employee but operates through a limited company or intermediary to benefit from tax advantages.
When a contractor falls “inside IR35,” they are considered an employee for tax purposes and are subject to PAYE (Pay As You Earn) income tax and National Insurance contributions (NICs). Conversely, if a contractor is “outside IR35,” they are genuinely self-employed and responsible for their own tax obligations, benefiting from tax efficiencies and greater control over their finances.
IR35 assessments determine whether a contractor is “inside” or “outside” IR35 based on the nature of their working relationship with the end client. An accurate assessment is important for contractors to avoid unexpected tax liabilities and for businesses to avoid penalties for incorrect classifications.
Who Is Responsible for the IR35 Assessment?
The responsibility for determining IR35 status depends on the size and type of the client organization:
- Public Sector and Medium/Large Private Sector: Since April 2021, the responsibility for IR35 assessments lies with the client (the hiring organization). They must assess each contractor’s status and communicate the determination.
- Small Private Sector: In cases where the client is a small business, the responsibility for the IR35 assessment remains with the contractor.
Clients and contractors should both be familiar with the IR35 assessment process to ensure compliance and avoid financial repercussions.
The IR35 Assessment Process Explained
The IR35 assessment process evaluates various factors to determine a contractor’s employment status. HMRC provides guidance on key factors that indicate whether a working relationship falls inside or outside IR35. Here’s an overview of the main components considered during the IR35 assessment.
Control Over Work
Control refers to the degree of autonomy the contractor has in carrying out their work. In general, a genuine contractor (outside IR35) should have more freedom over how, when, and where they complete their tasks. Key considerations for the control assessment include:
- Work Location: If the contractor is free to choose where they work, this supports an outside IR35 determination.
- Hours of Work: Contractors who set their own working hours are more likely to fall outside IR35, whereas fixed hours set by the client suggest employment.
- Method of Working: A contractor with control over their methods and processes—rather than following strict instructions from the client—is more likely to be outside IR35.
The level of control exerted by the client is a significant factor in the IR35 assessment process. High levels of control often indicate that the contractor is essentially an employee, leading to an inside IR35 determination.
Mutuality of Obligation (MOO)
Mutuality of Obligation (MOO) assesses whether there is an expectation for the client to provide continuous work and for the contractor to accept it. In a true contractor-client relationship (outside IR35), there should be no obligation for ongoing work once the project is complete.
Indicators of MOO include:
- No Obligation for Future Work: If the contractor can decline work after completing a project, this supports an outside IR35 determination.
- Project-Based Assignments: Contracts that specify a particular task or project, rather than open-ended employment, favor an outside IR35 status.
For an inside IR35 scenario, MOO is typically present, meaning the client expects the contractor to be available for ongoing tasks, and the contractor is expected to continue working.
Right of Substitution
The right of substitution refers to whether the contractor can send a replacement to complete the work if they are unable to do so. This is a significant factor in determining whether a contractor is truly independent or operating as an employee.
- Genuine Right to Substitute: A genuine contractor should have the contractual right to send a substitute to fulfill their duties if necessary. This right to substitution is a strong indicator that the contractor is outside IR35.
- Limited or No Right to Substitute: If the client only wants the contractor to do the work personally, this suggests an employee relationship and supports an inside IR35 status.
The right of substitution must be a practical and contractual right, not just theoretical. If it’s realistically possible for the contractor to arrange a replacement, it strengthens the case for an outside IR35 determination.
Provision of Equipment
In a contractor-client relationship, it is generally expected that the contractor provides their own equipment or tools to perform their work. Conversely, if the client provides most or all of the equipment, this could indicate an employment relationship.
- Contractor Provides Equipment: If the contractor brings their own tools or devices, it supports an outside IR35 classification.
- Client Provides Equipment: When a contractor relies on the client’s equipment, it suggests an inside IR35 scenario, as this aligns with typical employee arrangements.
This factor is usually combined with other criteria in the assessment but plays an essential role in determining the nature of the contractor-client relationship.
Financial Risk and Opportunity for Profit
One hallmark of a contractor’s independence is taking on financial risks and the opportunity to profit or make a loss. In an employment relationship, employees typically receive a fixed salary, which does not change based on project outcomes. Contractors, on the other hand, should have the opportunity for profit and the risk of financial loss.
Considerations for this factor include:
- Financial Responsibility: If a contractor is responsible for correcting any errors at their own expense, it supports an outside IR35 status.
- Project-Based Payments: Contractors paid by project, rather than on a fixed schedule, are often considered independent. Payment tied to project milestones also aligns with a contractor-client relationship.
- Risk of Loss: True contractors take on risks, such as losing income if a project goes over budget, which employees typically do not face.
Financial risk, along with the other factors, is used to determine if the contractor operates as a genuinely independent entity.
Steps to Take if You’re Subject to an IR35 Assessment
Whether you’re a contractor or a client, it’s essential to prepare for an IR35 assessment to ensure a fair and accurate evaluation. Here are steps to consider for both parties:
For Contractors
- Review Contracts Carefully: Ensure your contract terms align with your working relationship and avoid any terms that imply employment.
- Maintain Records of Work Practices: Document your working methods, substitution clauses, and examples of projects where you were paid by milestone or project rather than by the hour.
- Seek Professional Advice: If you’re uncertain, consider consulting with an IR35 specialist to review your contract and work practices.
For Clients
- Use HMRC’s CEST Tool: HMRC offers a Check Employment Status for Tax (CEST) tool that can provide a preliminary IR35 assessment. While it’s not binding, it can give you a starting point.
- Communicate with Contractors: Discuss the contract terms and working practices with contractors to ensure mutual understanding of roles and responsibilities.
- Seek Professional Guidance: IR35 regulations are complex, and obtaining advice from legal or tax professionals can ensure a compliant assessment.
Ensuring that your contracts and work practices accurately reflect the true nature of the relationship can help both contractors and clients avoid disputes and penalties.
Final Thoughts on the IR35 Assessment Process
The IR35 assessment process is a crucial step in ensuring compliance with UK tax laws and protecting both contractors and clients from potential liabilities. By understanding the criteria involved in IR35 assessments—such as control, mutuality of obligation, right of substitution, equipment provision, and financial risk—contractors and businesses can better evaluate their working arrangements and avoid misunderstandings.
With a careful approach to contracts, transparent communication, and awareness of IR35 requirements, contractors and clients can navigate the assessment process confidently and uphold fair, compliant working relationships. Whether you’re a contractor or a client, understanding and proactively managing IR35 obligations is key to avoiding complications and maintaining smooth, compliant business operations.
