Determining whether a contract is inside or outside IR35 depends on the individual’s employment status.
If challenged, HMRC will look at how the work is carried out in practice (the ‘working practices’) as well as the terms of the written contract.
In this guide, we look at the main status tests used by HMRC and the courts, and how these influence IR35 determinations.
The tests below apply to both the original IR35 rules in Chapter 8 ITEPA 2003 and the Off-Payroll rules in Chapter 10.
Although the responsibility for determining employment status changes under Chapter 10 (to end-clients, rather than the contractor), the underlying principles remain the same.
Control
Control is a significant factor in IR35 case law. It covers how much the client directs the contractor’s work.
HMRC looks at:
- who decides how the work is done
- who decides the order of tasks
- whether the contractor has autonomy over method and delivery
- whether the client can move the contractor between tasks
An outside IR35 engagement usually demonstrates a clear focus on deliverables rather than how the worker is overseen and directed.
Contractors with specialist expertise will typically bring their own approach rather than follow clients’ internal instructions.
Read HMRC’s guidance on control here: HMRC ESM0510.
Substitution
Substitution focuses on whether the contractor is obliged to perform the work personally or if they’re able to provide a substitute under certain circumstances.
A genuine right of substitution is strong evidence for an outside IR35 position.
A valid substitution clause must:
- allow the contractor to send another suitably qualified person
- give the contractor a genuine contractual right to do so
- leave the contractor responsible for paying any substitute
The fact that a right has never been used does not, by itself, make it invalid. However, the wording and scope of the right must be examined.
If the client insists the contractor must carry out the work personally, with no right to provide a substitute, this is a strong ‘inside’ IR35 pointer.
HMRC’s substitution guidance: HMRC ESM0530.
Mutuality of obligation
Mutuality of obligation (MOO) concerns the obligations on the client and the contractor during the engagement.
A contract of employment requires an obligation on the worker to perform at least some work personally and an obligation on the engager to provide work or payment.
The absence of any promise of further work after the contract ends does not, on its own, prevent the existing engagement from being one of employment.
Relevant points may include:
- whether the contractor is obliged to accept additional work
- whether the client must continue offering work during the contract
- whether the arrangement is based on defined deliverables or ongoing duties
Read HMRC’s stance on MOO here:
HMRC ESM0540.
Financial risk
Financial risk examines whether the contractor is running a genuine business.
Traditional client-employee relationships typically involve little financial risk for the individual. However, if you’re running a contracting business on your own account, this involves greater uncertainty and responsibility.
Signs that demonstrate that a worker carries some financial risk include:
- providing equipment or software
- maintaining business insurance
- quoting for work on a fixed price
- correcting mistakes at your own cost
- marketing to multiple clients
Read HMRC’s stance on financial risk:
HMRC ESM0550.
Read our guide to financial risk as a status factor
Integration and business structure
Another key question is how integrated the worker is within the client’s organisation.
Contractors working outside IR35 tend to operate at arm’s length and are not ‘part and parcel’ of the client’s organisation.
Here are some factors HMRC will consider when looking at how integrated the worker is:
- whether the contractor appears on staff lists
- whether they use internal HR or appraisal systems
- whether they manage employees directly
- whether they are subject to the same policies as employees
Working patterns also matter. A contractor who manages their own hours and location is more likely to be outside IR35 than someone working under the client’s standard working arrangements.
Length and pattern of engagements can also influence status. A long-running, open-ended role that resembles a permanent position is more likely to be viewed as employment than a short, project-based contract, particularly where the worker becomes embedded in the client’s organisation.
Read our guide to part and parcel as a status factor
Read our guide to contract length as a status factor
Equipment, insurance and business indicators
Another indicator of a worker’s employment status is whether they are genuinely ‘in business on their own account’.
Some pointers include:
- owning and maintaining equipment
- holding professional indemnity insurance
- having a business website or profile
- maintaining accounts and tax filings
None of these factors will determine someone’s IR35 status on their own, but they can help build the bigger picture of the contractor’s working practices.
Read our guide to being in business on your own account
The big picture
No single test can decide a contractor’s IR35 status.
In an IR35 case, the tribunal first identifies the terms of the actual contractual arrangements. It then constructs the hypothetical direct contract between the worker and the client before deciding whether that contract would be one of employment.
The written contracts are central to this exercise. Other evidence may also be relevant when establishing oral or implied terms, identifying a variation or considering the circumstances in which the services were provided.
A written term cannot simply be disregarded because it was never exercised or because the day-to-day arrangements developed differently. The Court of Appeal confirmed this in Atholl House.
The label placed on the relationship by the parties is not decisive. A statement that the worker is self-employed will not override contractual terms which amount to employment.
If the contractor provides a specialist service on a project basis, retains meaningful autonomy and operates an independent business, the engagement may be outside IR35. The final decision depends on the terms and circumstances of the particular engagement.