IR35 can be tricky to wrap your head around, so it’s no surprise most compliance mistakes freelancers make come from being confused, not careless.
Thankfully, knowing where people tend to go wrong makes it easier for you to avoid the same pitfalls.
In this article, we’ll cover the most common mistakes, why each one matters, and what to do instead.
First, though, let’s quickly go over the basics.
What is IR35?
IR35 is a set of UK tax rules designed to determine an individual’s employment status for tax purposes.
It was introduced as part of an initiative to clamp down on ‘disguised employees’ slipping through the tax-paying net.
But what’s a disguised employee?
Simply put, one who supposedly works for a client through their own limited company, when in reality the relationship is closer to that between an employer and employee.
In other words, they’re functioning as a typical employee.
Having an IR35 status isn’t a fixed thing; it works on a case-by-case basis, meaning the rules apply to each individual project you take on as a freelancer. So, you can be both inside and outside of IR35 for different clients.
Why does it matter?
You’ll be considered an employee for tax purposes, and your “client” (if they are a medium or large company) will typically deduct Income Tax and National Insurance contributions in the same way they would for an employee paid through their usual payroll.
It’s worth noting that even though you’re classed as an employee for tax purposes, you won’t get employee perks such as holiday leave, sick pay, etc. So, this is worth considering when you take on a project/client, because you’ll be losing the benefit of choosing how you pay yourself, along with no employee perks. If you work for a small business, it’s down to your own company to work out your status and pay any tax and NI due.
If you’re outside IR35, you aren’t considered an employee for tax. Your client will pay you in full, and you’ll report and pay tax on your earnings like any other limited company.
Key mistakes
Learning from where others have got it wrong can help ensure you get it right.
To start you off, let’s go through some of the biggest mistakes a freelancer can make.
Assuming IR35 doesn’t apply to you
IR35 is aimed at situations where an individual provides their services to a client through their own intermediary – most commonly a limited company or personal service company (PSC) – and would otherwise be considered an employee if they worked directly for the client.
In this sense, it’s the nature of the working relationship that determines someone’s IR35 status, not simply the label of ‘freelancer’ or ‘contractor.’
A basic rule of thumb is that if you’re being asked to work the same hours as a regular employee and lack control over when and where you work, you’re more than likely inside IR35.
While sole traders are not caught by IR35 itself, their employment status is still relevant.
For a sole trader, the question is whether they are genuinely self-employed for tax purposes.
Relying on the contract alone
To continue with the idea that it’s not just about the label, HMRC looks at how the contracted work is actually carried out in a practical way.
They consider the working relationship between a freelancer and a client, including factors such as who controls the work, whether the individual can send a substitute in their place, how they’re paid, and whether they’re operating an independent business.
Two of the big ones are whether you have a genuine right to send a substitute, and whether there’s mutuality of obligation, meaning any obligation to offer or accept work on either side, as there is between an employer and employee.
Accepting a status determination without question
Since 2021, it’s been for the client to decide whether a freelancer they’re working with falls within the remit of IR35 rules (so long as that client is a medium-to-large-sized private company).
Nevertheless, it’s important for freelancers to remember they have a right to contest a client’s verdict on whether they’re operating inside or outside IR35. Your client must give you a written status determination with reasons. If you disagree, they have 45 days to review it and respond.
If you undertake freelance work for a small private company, then the onus is on you to determine your own IR35 status, and you can do this using HMRC’s online CEST (Check Employment Status for Tax) tool.
Not adjusting fees when inside IR35
As we alluded to earlier, an IR35 status determination applies to a specific engagement, not to you as an individual.
This means that if you do find yourself inside IR35, you can actually just negotiate a higher fee or day rate to compensate for the deducted Income Tax and National Insurance contributions.
IR35 does not impose a cap on what a freelancer can charge; the commercial rate remains a matter for the contractor and client to agree.
Poor record keeping
Good record keeping is crucial for all sole traders and business owners, helping to keep you on track and organised for when it comes time to submit your tax returns.
It’s particularly important for IR35, though, as employment status depends on the facts of each separate project considered alone.
Accurate and up-to-date records provide evidence of how the arrangement actually worked, and so can support or oppose an IR35 determination.
In a nutshell, IR35 is determined by the reality of the working relationship between a freelancer and a client – not just what the contract says – and good records allow you to demonstrate that reality.
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