What is IR35 and how does it affect UK businesses?

IR35 is a word used to describe two sets of tax legislation that are designed to combat tax avoidance by workers, and the firms hiring them.

IR35 forms part of the Income Tax (Earnings and Pensions) Act 2003 ("ITEPA") and the Social Security Contributions (Intermediaries) Regulations 2000. The first piece of legislation, introduced in April 2000, is the Intermediaries Legislation (Chapter 8 ITEPA). The second piece followed this in 2017 called the off-payroll working legislation (Chapter 10 ITEPA).

The legislation applies to engagements where the services are provided through a limited company, referred to as the intermediary. If it's determined that the contractor is engaged like an employee, then the relevant employment taxes and National Insurance contributions will be due.

The party required to pay the taxes will depend on the size of the hiring firm, or "client", as defined by the Companies Act 2006. Where the hiring firm is small, the original intermediaries legislation applies, and the contractor is responsible for determining whether the engagement is "deemed employment" and paying the extra taxes. Under the off-payroll legislation, initially introduced into the public sector in April 2017 and extended to the private sector in April 2021, the hiring firm takes over that responsibility.

The off-payroll legislation presents a tax risk for medium and large UK businesses engaging contractors who are found to be subject to IR35. In that case, they may have to pay additional employment taxes and associated penalties if they fail to comply with the legislation.

Businesses must therefore assess the employment status of their contractors to determine whether or not the engagements are deemed employment and take steps to ensure compliance if necessary.