Operating outside IR35: what to know

Operating “outside IR35” means you’re working as an independent contractor outside of IR35 rules. In other words, your contract and working practices must demonstrate that you’re operating as a genuine business and not an employee of your end client.

Staying outside IR35 requires meeting specific requirements set by the HMRC. In this article, we’ll explain what being outside IR35 means and how to determine if your contract qualifies. We’ll also look at steps to ensure your contract is compliant, and what could happen if HMRC finds you in breach of the rules.

A quick note about IR35

Before we get started, let’s briefly establish what IR35 is.

IR35 is a piece of tax legislation introduced in 2000 (revised in 2017 and 2021), aimed at closing tax loopholes involving independent contractors. Basically, the UK Government wants to make sure employers don’t hire independent contractors as “disguised employees,” misusing off-payroll rules to avoid paying tax and National Insurance contributions.

We’ve previously discussed the ins and outs of IR35, so we’ll focus on being “outside IR35” this time.

What does outside IR35 mean?

Outside IR35 means you’re an independent contractor operating outside of IR35 rules. This means when an end client hires you for your services, you’re responsible for your salary and taxes. The end client simply pays you the fee as outlined in your contract.

Who determines your IR35 status depends on your end client:

If your end client is a private sector small business (as outlined in the Companies Act 2006), you’re responsible for declaring yourself outside IR35.

If your end client is a private sector medium to large business, they’re responsible for determining your status.

If your end client is in the public sector, they determine your status regardless of their business size.

If HMRC audits you and finds out your contract is actually inside IR35 rules and not outside, you’ll have to pay back all the taxes and National Insurance contributions you missed since the contract started, plus interest. You may also face significant penalties if the HMRC thinks you deliberately misused outside IR35 status for tax avoidance.

Are you looking for insurance cover to support your business? Get in touch with us! A member of the Howden team would love to help you find the perfect policy!

Get a Quote

What’s the difference between inside and outside IR35?

Being outside IR35 means managing your salary and taxes after the end client pays you, but what does being “inside IR35” entail?

When you’re inside IR35, your end client treats you like an employee for tax purposes. That means your take-home pay will have income tax and National Insurance automatically deducted before you receive it. However, you don’t get employee benefits like paid holidays or sick pay because you’re still a contractor.

The key difference is your tax rate. Operating outside IR35 rules means you pay taxes as a business. Being inside IR35 means you pay income tax and National Insurance contributions like a regular employee.

How do I know if my contract is outside IR35?

Usually, your end client decides whether your contract is outside IR35, but sometimes you have to do it yourself. You can do this using the HMRC’s Check Employment Status for Tax (CEST) tool or by hiring a third-party IR35 compliance assessor. 

You can also use the IR35 status test — a series of questions designed to help you confirm that your contract is outside IR35. These questions are:

• Right of substitution: Can you send another contractor to do the work on your behalf? (Yes, for outside IR35)
• Control: Do you have control over when, where, and how you do the work? (Yes, for outside IR35)
• Mutuality of Obligation (MoO): Does the contract end when the project is complete, with no expectation of further work outside the scope of your contract? (Yes, for outside IR35)
• Financial Risk: Do you cover your business expenses, like equipment and insurance? (Yes, for outside IR35)
• Part of the organisation: Does your name appear in your end client’s internal staff list? Are you eligible for your end client’s employee benefits, such as bonuses? (No, for outside IR35)
• Right of dismissal: Can your end client terminate the contract immediately without a notice period? (No, for outside IR35)
• Exclusive services: Do you work for one end client exclusively? (No, for outside IR35)
• Office holders: Do you have a management role within your end client’s business? (No, for outside IR35)
• Intention: Did your end client sign a contract for services instead of a contract of service? (Yes, for outside IR35).
  • Note: The determination here is that a “contract for services” is for an independent contractor, while a “contract of service” is for an employee. Clients hire contractors for their services (a range of functions they provide), while employees are hired for their service (a continuous, ongoing role within the company).

How do I ensure I have an outside IR35 contract?

To ensure your contract is outside IR35 (even if your end client is responsible for deciding if you are), have a third-party IR35 compliance expert review it. They can advise you on potential issues that could affect your outside IR35 status, helping you avoid a large tax bill if the HMRC decides to audit you later.

You can also use the HMRC’s online CEST tool and perform the IR35 status test yourself. However, HMRC may challenge the results during an audit, so make sure you keep detailed records of your business activities, working practices, contracts, and communications to support your case.

Why should I keep my contract outside IR35?

Your IR35 status depends primarily on your contract details, so we can’t advise whether you should stay outside IR35. However, making sure your contract is classified correctly means you’re paying the right amount of tax and won’t have a surprise tax bill later.

What if my outside IR35 contract is found to be inside IR35?

If HMRC finds your contract is inside IR35, you’ll need to repay any missing tax and National Insurance contributions, plus interest, from the start of your contract. Your contract will also be reclassified as inside IR35 going forward, which means your take-home pay is taxed at source.

You can appeal HMRC’s decision and hire an IR35 expert to help with your case. If your first appeal is unsuccessful, you can re-appeal to a Tax Tribunal and then to the higher Courts. Keep in mind that this could cost your business significant legal fees, as IR35 investigations and appeals are time-consuming.

You may also be subject to penalties if the HMRC thinks you’ve deliberately misused the outside IR35 status for tax avoidance. If so, you’ll be charged a penalty on top of your tax bill. The penalty is calculated based on what HMRC thinks they would’ve lost in tax revenue if there hadn’t been an enquiry.

Quickfire summary: What is outside IR35?

Working “outside IR35” means you’re not an employee, but an independent contractor providing services for an end client as a genuine business. That means you’re responsible for paying your taxes, and the end client simply pays you as agreed in your contract.

Your end client’s business size determines which party classifies your contract as IR35:

• If your end client is considered a small business, you classify yourself as outside IR35. 
• Medium to large businesses in the private sector are responsible for declaring contracts as outside IR35.
• Businesses of any size in the public sector are responsible for classifying contracts as IR35.

You can confirm your IR35 status using the HMRC’s Check Employment Status for Tax (CEST) tool or by hiring an IR35 expert. You can also perform the IR35 status test, which helps you evaluate your contract based on key things like control, financial risk, right to substitution, and mutuality of obligation.

If the HMRC audits your contract and finds it’s actually inside IR35 rules, you’ll need to repay all the tax and National Insurance contributions you owe since the contract started, plus interest. Your contract will also be reclassified as inside IR35, which means your pay will be subject to income tax and National Insurance deductions.