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It comes as no surprise that HMRC in the UK is taking action on regulating the arrangements with independent contractors. With prolonged furloughs and the insecurity surrounding BREXIT, more and more UK-based businesses are shifting to contingent workforce and prefer independent contractors versus hiring full-time employees.However, there is a thin line between classifying a worker as an independent contractor instead of as an employee, especially when it comes to hiring remote teams. IR 35 is supposed to shed light and introduce a set of more clear rules for businesses to follow.Who is an IR35 independent contractor?IR35 is also called intermediaries’ legislation. It was introduced in the year 2000. This legislation is designed to lower tax avoidance by freelance contractors who HMRC views as “disguised employees.”To understand the rule, you need to understand the difference between an employee and an independent contractor. In some cases, a contingent workforce comprises full-time employees in substance as they work out of the premises of the employer, use equipment that belongs to the employer and their working hours or the so-called ” time in and out” is in line with the policies that apply to the full-time employees of the employer. However, instead of being on payroll aka Pay As You Earn, these workers bill for their services through their limited firms. Needless to say, this approach increases the tax efficiency for all sides involved in the working arrangement.The majority of sole trader limited firms operating in the UK rely on arrangements involving independent contractors to save themselves from providing employment benefits and lower the tax burden.To deal with this prevalent issue, IR35 legislation is designed to ensure that those independent contractors who deliver their services through limited companies doing the same work as the full-time employees employed by the same business, will be classified as employees and pay the same income tax rate and National Insurance contributions as those employees that are on Pay As You Earn. HMRC inspectors may apply an employment test on a case-by-case basis based on the working practices and the substance of the working arrangement, instead of on the contractual terms and the language used in the respective contract signed by and between the parties. Put simply, stating that the provider of services is an independent contractor is not sufficient to classify the arrangement out of IR35.Moreover, on top of the proper classification of their workforce, UK-based businesses need to address the billing and payment needs of their contingent workforce.Remote working arrangements are even more complex as UK citizens and foreigners having a fully settled status in the UK may be working overseas due to Covid-19 lockdowns in the UK. The increased administrative burden has pushed many HR managers to look for software solutions like the UK-based Transformify FMS that helps businesses fully automate billing and payouts to 184 countries ensuring that both independent contractors and their employers are in compliance with the applicable legislation. With the UK leaving the EU, most independent contractors are in confusion as to whether they need to charge VAT, if the invoices they issue are in compliance with the tax legislation, etc. Here’s a rundown of things to keep in mind.IR35 rulesA contract may be ” inside IR35” or ” outside of ‘IR35” depending on the arrangement. If a contract is deemed to be ”inside IR35,” the worker is to be classified as an employee and subject to the same National Insurance and income tax burden.On the contrary, if the contract is considered to be ”outside of IR35,” the worker is classified as an off-payroll independent contractor. Mutuality of obligationWorking as a self-employed contractor implies that an employee can work on a project basis without any obligation to keep working for the client once the respective contract terminates.In the same way, clients also do not have any obligation to keep offering contracts when the existing project is completed. A client and an independent contractor will fall ”inside IR35 contract” if the client has to compulsorily offer paid work to the contractor, the pay rate is not directly related to the work that has actually been delivered, there are no clear deliverables and KPIs, the independent contractor is entitled to employment benefits like paid sick leave and annual paid leave, uses equipment provided by the client, the client has the right to control the time in and out and the number of hours the independent contractor spends on each task, etc.There is another condition under IR35 that allows independent contractors to sub-contract their work and work for multiple clients at once. That said if an agreement stipulates that the independent contractor has no right to sub-contract or undertake other clients, unambiguously the independent contractor will be classified as an employee. SubstitutionIf a contract clearly stipulates that the independent contractor has to be present throughout the project and work out of the premises of the client, then also this kind of work relationship comes under the spectrum of “inside IR35″ rules. If a substitute worker can replace the previously appointed independent contractor and deliver the work specified in the contract, then the arrangement is likely to be classified as ”out of IR35.”Supervision, Direction, ControlAnother condition where the contract fails to fall within IR35 is when contractors clearly demonstrate that they have control over the methodology applied to accomplish the work.On the other hand, if the client decides on the working patterns and controls the way the project has to be completed, then such a contract is very likely to be classified as ”inside IR35″ and the worker is to be classified as an employee, not as an independent contractor.The Equipment UsedIf the client provides tools or equipment to complete the work on a contract, and the independent contractors uses the equipment only to complete the work for this particular client and can not use it to deliver work to other clients, then HMRC may view such arrangement as a ”disguised employee” and insist on classifying the independent contractor as an employee. In most cases, making it clear at the pre-contract stages that independent contractors will use their own equipment and software licenses where applicable, to complete the project will keep the arrangement outside of IR35 if all other requirements have been satisfied.Financial RiskSelf-employed independent contractors are more likely to experience a higher level of financial risk as compared to an employee. The financial risk arises from the need to invest money into the daily execution of the business. If the work delivered to the client seems to be substandard or faulty, then the independent contractors often need to spend more time and invest additional resources to address the quality requirements at their own expense.Consequences of Misclassifying IR35 ContractorsIf a contract falls within IR35 rules, then the independent contractor is to be classified as an employee. In other words, the parties may be accountable to pay the unsettled additional income tax along with National Insurance contributions.Private-sector employers who hire independent contractors will be accountable to determine their IR35 status. As this is seen as an administrative burden by lots of businesses, many SMEs prefer to outsource the task to companies specializing in off-payroll arrangements.HMRC can go back in time to determine whether or not IR35 applies to previous work that the independent contractor has carried out. In case that a particular arrangement is classified within the scope of IR35, HMRC may request additional income tax and National Insurance contributions to be paid along with interest and penalties.To save business owners from the financial consequences of misclassifying IR35 independent contractors, it becomes essential to run an IR35 test each time a new arrangement is negotiated.Determination of employment status has always been a tricky decision for many businesses. Yet, there are a few simple ways to ensure that they are in compliance with IR35 rules:Take the IR35 testFigure out whether the arrangement is are present ‘outside’ or ‘inside’ IR35. This can be done by taking the HMRC IR35 test for the assessment of the existing work practices.Review the existing practicesOnce you have the results of the HMRC test, you should carry out an audit of the existing work practices. It is important to see how IR35 impacts the way a company carries out its daily business. This analysis will help solve a wide range of potential issues.Seek an expert opinionBefore you make any modifications in the way you conduct your business, it is beneficial to seek advice from law experts. Ensure that the changes you are planning to introduce comply with IR35 and other related regulatory requirements. There are many nuances and industry specifics that are to be considered on a case-by-case basis.The impact and benefits of IR35 rules are still yet to be seen in the private sector. However, familiarizing yourself with IR35 rules and their impact on the public sector can result in many advantages for your business.