How to assess IR35 status for all UK-based contractors

What is IR35 and why does it matter?

IR35, also known as the ‘off-payroll working rules’, is a set of tax laws designed to prevent tax avoidance by contractors who are, for all intents and purposes, employees. Getting this assessment wrong can be costly, leaving your business liable for unpaid taxes, interest, and significant penalties from HMRC.

The rules place the responsibility on you, the client, to determine whether a contractor should be treated as an employee for tax purposes. If they are deemed ‘inside IR35’, you must deduct Income Tax and National Insurance from their fees, just as you would for a regular employee.

A quick note on company size: If your business meets at least two of the following criteria, you are legally required to follow these rules: an annual turnover of more than £10.2 million, a balance sheet total of more than £5.1 million, or more than 50 employees. However, even if you are a small business, it is best practice to understand and assess IR35 status to protect yourself from future risk.

Key factors that determine IR35 status

HMRC considers several factors to build a picture of the working relationship. No single factor is decisive; it’s about the overall picture. The main areas are:

• Control: How much say do you have over how, when, and where the contractor performs their work? A genuine contractor will typically have a high degree of autonomy. An employee is more likely to be directed by a manager.
• Substitution: Does the contractor have a genuine right to send a substitute to do the work in their place? If they must perform the service personally, this points towards an employment relationship (inside IR35).
• Mutuality of Obligation (MOO): Are you obliged to offer work, and is the contractor obliged to accept it? In a genuine business-to-business relationship, there is no obligation to offer or accept future work once a project is complete.

How to assess your contractor's status

Follow these steps to carry out a compliant IR35 assessment.

1. Gather your information: Collect the written contract and detailed information about the actual day-to-day working practices. The reality of the relationship is more important than what the contract says.
2. Use the CEST Tool: Go to the government's Check Employment Status for Tax (CEST) online tool. This is a free, anonymous questionnaire that guides you through the key factors. Answer the questions accurately based on the working practices.
3. Issue a Status Determination Statement (SDS): This is a mandatory step. The SDS is a written document that states your decision (e.g., 'inside IR35' or 'outside IR35') and the reasons behind it. You must provide this to your contractor. This is crucial as it proves you have taken 'reasonable care' in your assessment.

What to do after the determination

Your actions depend on the outcome of the assessment:

• If the contractor is 'Inside IR35': You (or the agency that pays the contractor) must operate payroll. This means deducting Income Tax and National Insurance Contributions from their pay before you pay them.
• If the contractor is 'Outside IR35': The relationship is confirmed as a business-to-business service. You can pay their invoices gross, and they remain responsible for managing their own company's taxes.

Our Top Tip: Keep meticulous records of every SDS and the information used in the CEST tool for each contractor. If the scope of their work or their working practices change, you should carry out a new assessment. If you are ever in doubt, it is always best to seek advice from an accountant or a tax specialist who understands IR35.