Q1: What is IR35 and how does IR35 work in freelance contracts?
IR35 is a piece of tax law that is designed to combat tax avoidance by provide their work, usually for a single client, via a limited company, and who would be an employee if the ‘intermediary’ limited company was not used. These workers are called ‘disguised employees’ by HMRC. They are employees in all but name.
The ‘intermediary’ company or ‘umbrella’ company is referred to as a ‘personal service company’ (“PSC”). The worker does not contract directly with any clients. Contracts are signed between the client and the PSC. The PSC is paid by the client to supply the worker’s services. If you provide services via a PSC then you need to be careful to do so within the IR35 rules so that you are treated as truly freelance and not employed.
If IR35 applies then the income of the PSC is regarded as the worker’s personal earnings and income tax is chargeable as well as Class 1 NICs and other benefits received by that worker.
Q2: Why does it matter to distinguish between self-employment and employment?
It matters a lot in terms of (1) legal status and (2) tax. When a worker has the legal status of an employee as opposed to a self-employed person, it has big consequences for both the worker and the employer. This is because (1) employees get a different level legal protection than self-employed persons; and (2) from a tax angle it determines whether tax is paid under Schedule E (personal income tax) or D and whether national insurance contributions (NICs) are paid as a class 1 or class 2 contributor.
Q3: So am I freelance/self-employed or employed?
If you are working under a ‘contract of employment’ then you are an employee. If you are working under a ‘contract for services’ then you are a self-employed person, i.e. freelance or an independent contractor. But it is not that simple……. it doesn’t matter what label your contract might give itself (e.g. “freelancer”, “sole trader”, “self-employed”, “individual contractor”). The courts will study the reality of your situation and not the title attached to your contract.
Indicators of being freelance/self employed (as opposed to being employed) include:
(1) Where there is a contract for services, not a contract of employment. For this purpose it should not contain terms providing for, e.g. holidays, sickness, and disciplinary measures etc.
(2) Appropriate wording can be of some importance, so refer to worker as “self-employed” and paid a fee, not a salary or wage.
(3) No “mutuality of obligations” or control over the worker.
(4) If the contract requires that the worker “personally provides services”, then it does not matter if you have a right to substitute someone else for yourself, that right is effectively negated.
Q4: How does a court decide whether someone is freelance/self-employed or an employee?
There is a central test to meet in determining that an individual is truly ‘freelance’ which is whether, in carrying out his/her work, the worker in question is carrying on a ‘business’.
A Court will take into account many features of a relationship in judging whether someone is carrying on a business, only a few of which are listed above.
Q5: What clauses can I put in freelance contracts to help them be compliant with IR35?
A carefully worded contract that acknowledges the independence of the ‘freelance’ worker is a key starting point. The contract should attempt to reduce the risk that (a) the worker might be deemed to be a de-facto employee rather than a self-employed contractor in the context of employment and tax law and (b) the risk that IR35 will apply.
To minimise the risk of IR35 applying where a PSC is used by a worker, there should be a suitable contract between the PSC and the client which has the features of a contract for services (and not those of a contract of employment). There should also be a suitable contract between the PSC and the worker.
Q6: What are useful clauses to establish a freelance contract?
- Mutually non-exclusive: The appointment of the Freelancer [you could alternatively use ‘Company’, ‘Individual’ or ‘sub-contractor] under this Agreement is mutually non-exclusive that is to say that at any time the Freelancer can provide to other persons and clients services which are the same as or similar to the Services and the Client [could alternatively use ‘Company’] can engage any other person or employee to provide it with services which are the same as or similar to the Services.
- No partnership or fiduciary relationship: Nothing in this Agreement shall create or be deemed to constitute or give rise to a partnership, joint venture, agency or any employment relationships between the parties, or any other fiduciary relationship, other than the contractual relationship expressly provided for in this Agreement.
- No continuing commitment: The grant/acceptance of this appointment does not create any mutual obligations on the part of the Client or the Freelancer to offer/accept any further appointment and no continuing relationship shall hereby be created or implied.
- Status & taxes: The Freelancer’s relationship with the Client is that of an independent contractor and the Freelancer shall have the status of a self-employed person. The Freelancer shall be responsible for all taxes and contributions (including, but not limited to, income tax and national insurance, where applicable) in respect of all amounts paid or payable to the Freelancer under or in relation to this Agreement
- Taxes indemnity: The Freelancer hereby agrees to indemnify the Client in respect of any claims that may be made by the relevant authorities against the Client in respect of any such taxes and/or contributions, including interest and penalties, relating to the Services provided to the Client under this Agreement.
- Expenses: The Freelancer shall be responsible for all of his/her expenses and, where applicable, VAT.