This informal CPD article ‘IR35 Rules: A Student's Guide to UK Tax Compliance’ was provided by Kairos-K, an organisation providing accounting services within the UK.
What is IR35?
Think of IR35 as the tax system's way of saying, 'Nice try, but we see what you're doing.' It's designed to identify people who are essentially employees, but who have set up their own companies to avoid the higher taxes that come with regular employment (1).
Here's how it typically works: instead of being on a company's payroll, someone sets up their own limited company and gets paid through that. This allows them to pay corporation tax (which is lower) and take money out as dividends (which are taxed more favourably), rather than paying the full amount of income tax and National Insurance that employees face.
The main problem that IR35 solves
Let's think about two situations to get our heads around what IR35 is trying to stop:
Scenario 1: Freelance Designer (Sole Trader)
Meet Alex, a graphic designer who works for himself. Alex has a bunch of clients, sets his own rates, uses his own equipment, and can turn down projects he's not keen on. When he's really busy, Alex sometimes brings in other freelancers to help out. Alex pays income tax and National Insurance on all his earnings, so IR35 doesn't apply here.
Scenario 2: The same work, but with a different structure (limited company).
Now, picture Emma, who does the same design work through her company. But Emma only works for one client and she's based in their office, using their computer and following their design guidelines, and she works the standard 9-5. The company pays Emma's company, and she takes most of her money as dividends (which are taxed at lower rates) rather than salary. Even though the way the company is set up makes it look like Emma is an employee, the way the company is structured means she is paying a lot less tax. That's exactly what IR35 targets: it's the same job as a regular employee, just with business clothes on.
How HMRC decides who's an employee and who's not
HMRC are looking to identify if you're really running a business or just pretending to be self-employed. They use three main tests:
1. The Control Test: "Who's the Boss?"
At the end of the day, it's about who's in charge. Does your client tell you exactly when to start work, where to sit, which software to use, and how to do every little task? That sounds like a boss giving orders to an employee.
Real contractors get to say things like "I'll deliver your website by Friday, but I'm working from my home office and using my preferred coding tools." If you're being micromanaged like a regular employee, HMRC will probably raise an eyebrow.
2. The Substitution Test: "Can you send your mate instead?"
Here's something a bit strange - could you send someone else to do your work? It doesn't matter if you'd never actually do this, but a proper business should have the right to provide a substitute worker.
Just think about it for a minute. If you hired a plumbing company and they sent a different plumber than expected, you wouldn't care as long as your pipes got fixed, right? But if your "contractor" is so personally tied to the role that only they can do it, that starts looking suspiciously like employment.
3. The Mutuality Test: "Are You Stuck Together Like Glue?"
This looks at whether you and your client are locked in an ongoing relationship where they've got to give you work and you've got to take it. Real businesses can say "sorry, I'm too busy this month" or "that project isn't for me."
If you're expected to be on call all the time and they're always giving you work, it starts to feel more like a permanent job than a business relationship.
Practical Examples of Employment vs. Self-Employment
Likely Employment Relationship:
- Working exclusively for one client for extended periods
- Using the client's equipment and software
- Following the client's standard working hours and procedures
- Having work closely supervised and directed
- Receiving regular monthly payments regardless of project completion
Likely Genuine Self-Employment:
- Working for multiple clients concurrently
- Using own equipment and premises
- Setting own working schedule and methods
- Taking financial risk (paying for materials, potential project losses)
Billing based on project completion or deliverables
HMRC financial penalties
The consequences of not understanding IR35
If HMRC decides that IR35 applies, there are several financial penalties that follow:
Back taxes: You must pay income tax and National Insurance contributions as if you were employed.
This means you need to calculate the tax for those years as if you'd been on the payroll the whole time. Instead of paying lower corporation tax and dividend rates, you'll pay the full employee tax rates for the past year, which can double or triple your tax bill.
Interest charges: This is used for late tax payments.
HMRC charges interest from the original due dates, not from when they catch you. If you haven't paid your taxes for three years, you'll have to pay three years of extra interest on top of the taxes you owe. This can add thousands to your bill.
Penalties: There will be extra fines for people who do not follow the rules.
These are extra charges for breaking the law, and they are usually calculated as a percentage of the unpaid tax. Think of it as HMRC's way of saying, "Here's an extra fine for making us chase you."
Employer responsibilities: Medium and large companies must decide if their workers are affected by IR35 and make the necessary deductions.
Since 2021, larger companies can't leave it up to contractors to figure out IR35. They must decide each contractor's status and deduct taxes accordingly. This means that the responsibility for meeting tax obligations now lies with the hiring company.
Protection Strategies
Professional Contract Review
Specialized lawyers can examine working arrangements for IR35 compliance issues. They identify problematic clauses and suggest improvements to strengthen the self-employment position.
IR35 Insurance
Insurance policies can cover legal costs of defending against HMRC investigations or, in comprehensive policies, actual tax liabilities if determinations go wrong.
HMRC's CEST Tool
The Check Employment Status for Tax tool gives you official guidance on IR35 status. HMRC will accept the result from the tool, as long as the information entered is correct (2) (3). It's completely free to use and available 24/7.
The tool works like a digital interview, asking you specific questions about how you work. You'll answer questions about the three main tests we talked about earlier:
Questions about control (e.g. who decides how, when and where you work)
Questions about substitution? For example, would it be possible to send someone else to do the work?
Questions about mutual obligations (e.g. are you required to accept work, and is the client required to provide it?).
At the end, you'll get a message about your employment status for tax purposes. You can print this off. The result will be one of three things:
- Employment: You should be treated as an employee for tax reasons.
- Self-employment: You can work outside IR35.
- We are unable to determine: The situation is too complicated for the tool to make a decision.
Questions should be answered truthfully. If you lie, it won't help you if HMRC investigates later. The tool can only make a decision when it has all the facts. If you see 'unable to determine', you should get professional advice. Make a copy of the results page as proof of your assessment. This step is very important.
Documentation
Maintaining detailed records of business practices helps demonstrate genuine self-employment. This includes evidence of multiple clients, business expenses, risk-taking, and independent decision-making.
International Considerations
IR35 rules apply based on tax residency rather than physical work location. UK tax residents face IR35 obligations regardless of where they work globally. Non-residents typically avoid IR35 if they don't process income through UK tax systems, though other countries have similar regulations.
Industry-Specific Issues
People working in construction face more complicated rules because there is another system called CIS which works alongside IR35 (4). Both systems aim to stop people avoiding tax, but they do this in different ways. IR35 takes precedence, meaning construction workers still need proper employment classification even if they are registered with the CIS.
Key Takeaways for Students
Understanding IR35 is crucial for accounting students because:
- Client Advisory: Future accountants will help clients navigate these rules
- Compliance Importance: Incorrect classifications carry significant financial consequences
- Business Structure Impact: These rules influence how people structure their working arrangements
- Tax Planning: IR35 affects legitimate tax planning strategies
The fundamental principle is substance over form - HMRC examines actual working relationships rather than just contractual language. Successful IR35 compliance requires aligning both documentation and genuine business practices with self-employment characteristics.
Final thoughts
IR35 is the government's way of making sure taxes are collected fairly while also keeping businesses flexible. If you work in accounting, understanding these rules will help you to provide better service to your clients. It will also help businesses to operate within the law while making the most of any tax benefits.
The key is understanding that IR35 compliance isn't just about paperwork. It requires real business activities and working practices that show true self-employment rather than disguised employment relationships.
We hope this article was helpful. For more information from Kairos-K, please visit their CPD Member Directory page. Alternatively, you can go to the CPD Industry Hubs for more articles, courses and events relevant to your Continuing Professional Development requirements.
REFERENCES
- https://www.gov.uk/guidance/understanding-off-payroll-working-ir35
- https://www.tax.service.gov.uk/guidance/check-employment-status-for-tax/start/disclaimer?c=1
- https://www.gov.uk/guidance/check-employment-status-for-tax
- https://www.gov.uk/what-is-the-construction-industry-scheme
