IR35 and previous employment – Key factors to take into consideration
Individuals who have previously worked for their client as a permanent employee risk being captured by IR35, meaning their income will be subject to the PAYE tax and NI contributions. Having worked for your client previously doesn’t automatically mean that you will fall within scope of IR35 and be viewed as a disguised employee in the eye of HMRC but may be an indicator that an employment relationship still exists which contradicts with an independent contractor status.
Below is an insight into measures that may be taken into consideration when assessing the impact of a previous employment relationship:
- Length of employment – the longer an employment relationship lasted for, generally, the more integrated an individual will be into the workforce of that client. This could make it harder for a contractor to be able to operate in a way which is truly independent from their client.
- Break in services – a contracting engagement which begins within 12 months of the termination of the employment can cause a higher risk to IR35 compliance, as there is little evidence of separation between the two engagements. What a contractor does during their break in services can also be a factor in the I3R5 assessment. Ideally, other clients should be serviced through the limited company in order to demonstrate that the contractor is building a client base and establishing a business, however other employment can go some way to showing that there is a separation between the employment and the consultancy role.
It is likely that, where a contracting role begins immediately following the termination of the employment, the assignment will fall within the scope of IR35. There is no clear guidance on the meaning of ‘immediate’, but inference can be drawn from Section 210 Employment Rights Act 1996. It is stated that a break of 1 week or less is insufficient to break the continuity of employment, and so an assignment is likely to be captured if the break in services is less than 7 days.
- Awareness of the assignment – It can be detrimental if an employee becomes aware of a contracting position and sets up a limited company in light of this, as there is a suggestion that rather than wanting to establish a business, the contractor is solely focussed on financial gain. Ideally, the contractor would become aware of the consultancy role after the termination of their employment and following the inception of their limited company.
- Environmental similarities – Returning to the same site, desk, reporting structure and colleagues can signify that the contractor will remain integrated into the client workforce much in the same way that that were as an employee, as it will seem that the contractor is simply working in the same way as they did as an employee.
- Role – There should be a significant difference between the employment role compared with that of the contracting role in order to show that the contracting engagement is truly independent. Where the tasks undertaken are the same or somewhat similar, it may be difficult to conclude that the two engagements are separate.
It is beneficial if an independent contractor is engaged to work on a specific project or body of work, and that the tasks to be undertaken have been pre-agreed at the outset of the assignment. This goes some way to demonstrate that the contractor is not at the beck and call of the client by being obliged to complete ad-hoc tasks in a similar way to an employee, and also that the client only has a temporary requirement for the services of the limited company, in comparison to the open-ended need for a permanent employee.
- Personal Service – The requirement for a specific individual to undertake the tasks under an agreement is highly indicative of an employment relationship. Therefore, within a contracting relationship, personal service should not be present. As the contract is in place with the limited company, it should be acceptable for any person to perform the services on behalf of that company. This is called the right of substitution and is fundamental to IR35 compliance. Where there has been a previous employment relationship, it can be advantageous to obtain confirmation from a client that a suitable replacement to carry out the services will be accepted (or to actually provide a substitute in practice) as this will serve as good evidence that the client isn’t merely obtaining the service of a specific individual through an alternative to employment.
- Presence of employees – independent contractors should be engaged to provide services and functions that a client’s own workforce cannot provide due to a lack of skills, knowledge and experience. It is clearly detrimental to a contractor’s IR35 status if they are performing the same role as an employee. Where employees of the client are carrying out similar tasks, it is imperative that substantial differences can be demonstrated in order to distinguish the role of the contractor as being above and beyond that of any employees.
- Intention of the Contractor – Not only do HMRC consider the day-to-day working practices of a contractor when assessing IR35 compliance, but the extent to which the contractor is truly managing a business is also taken into account. Where there exists a previous employment relationship, it is beneficial if the contractor can prove that they have chosen contracting as a lifestyle choice, rather than to reap the financial rewards. Proof of seeking work with alternative clients can go some way to showing a positive intention.
- Contract – whilst it is the relationship in practice between a contractor and their client which bears more weight on IR35 compliance, the existence of a consultancy agreement or contract for services which adequately sets out a business to business relationship will ultimately strengthen the IR35 compliance of an assignment.
The above is not an exhaustive list which, if followed, will absolve any of the risks related to previous employment and the impact that this has upon IR35 compliance. Employment status is assessed on a case-by-case basis taking into account the individual facts of each case, but it is worth being aware of the impact previous employment could have if this is something you are considering in the future.
If you are unsure of how your individual circumstances affect your IR35 status speak to a specialist adviser who can complete an IR35 review on your behalf.