IR35 was introduced in 2000 as part of the intermediaries legislation and its sole aim was to stamp out tax avoidance by clarifying the law. Unfortunately for contractors the legal implications of IR35 are complex and the system can be extremely difficult to navigate without the help of an umbrella contractor company.

The main thrust of the IR35 regulations revolves around people working via limited companies. In effect the legislation subjects individuals who have taken up a contract of employment with a third party via such a company to the same tax obligations as full-time and part-time employees.

Created to prevent people deemed by the Inland Revenue to be employed from claiming self-employed tax status, IR35 regulations dramatically changed the contractor tax landscape.

The impact of falling under IR35 legislation should not be underestimated by contractors. In a limited company situation, contractors typically draw a modest salary and the rest of their pay is in the form of a dividend – reducing their tax burden. But if the contract falls within IR35 rules, a contractor's pay will be significantly reduced. This is because instead of a dividend, a contractor would have to draw his wage from a deemed payment, which would be subject to standard income tax and national insurance contributions.

Fortunately, there are a number of ways to comply with IR35 and avoid bearing the brunt of income tax and national insurance contributions. Unfortunately the process requires the contractor to follow a number of very strict rules. When starting a new contract, the contractor must ensure that the terms surrounding the agreement of employment, as well as the manner in which the work is carried out, are compliant with IR35 rules. Contractors need to be regarded as just that, not employees of the company they are entering into the agreement with. When assessing a person's tax status HM Revenue and Customs will look at a number of markers that could single them out as an employee. The government body will look at the overall picture of the work carried – which can span multiple contracts. If a contractor works on a large project – or even on multiple contracts for the same company – and has equipment provided to them, then they are likely to be deemed an employee and subjected to standard income tax and national insurance contributions. Likewise, if the contractor has no responsibilities or there is very little risk involved in the role, this will count against them.

Things like financial risk, the equipment used and levels of responsibility are all considered when HMRC assesses a person's employment status. But there are a number of other factors as well, including if the person works for a single client, whether or not the contractor has fixed hours, whether the contractor gets job perks – like sick pay – and if there a bonus scheme in place for when work is completed to a satisfactory standard. There are many more considerations to take into account, particularly on the contract of employment side of things, which is why a professional umbrella contractor company should always be consulted when taking on work.

There has been much opposition to IR35 since it was introduced. In fact the Professional Contractors Group (PCG) has been battling against IR35 ever since its inception. In 2001 the organisation petitioned the Court of Appeal, asking for a review of the legislation. But the PCG's appeal was thrown out. As of 2002, PCG has instead focused on using case law to protect contractors under investigation. The organisation has long called for IR35 to be reviewed. However, IR35 is set to be reviewed as part of a "wholesale review of all small business taxation" and could even be abolished. Part of the reason for the review must be the limited tax income that the IR35 legislation has generated since its introduction.