What is IR35?
Defined by HMRC as ‘off pay-roll working’, IR35 takes its’ name from the original press release by Inland Revenue (now HMRC) when it Introduced the bill in April of 2000. IR35 is a two-part legislation, aimed at curbing tax evasion, by workers and organizations that hire them, using an intermediary or a limited company, also known as a Personal Services Company (PSC). The law wants to ascertain if a contractor is indeed a genuine contractor or a ‘disguised employee’.
An intermediary would typically be a worker’s own personal services company, but can also be;
- A partnership
- An individual
- Limited company
Why was IR35 introduced?
Working under an umbrella company, or as an employee does not entail the same tax efficiency as working as a contractor. As a contractor you can pay corporation tax at 19% of your profits, pay yourself via dividends and make minimal National Insurance Contributions (NIC), and claim business costs against your tax bill.
Contractors working in the same manner as employees, gain a tax advantage, intentionally or unintentionally compared to others working in the same way. The purpose of IR35 hence is to curb this unfair advantage, for both contractors working as ‘disguised employees’ and corporations that use them to avoid paying income tax and NIC’s.
Are you IR35 compliant?
IR35 requires contractors to interpret a complex set of employment status tests, to determine if their contracts place them ‘Inside (IR35 applies)’ or ‘Outside (IR35 not applicable)’ within the scope of the legislation.
Broadly but not limited to, three sets of principles determine your employment status (whether your contract falls ‘inside’ or ‘outside’ of IR35), also known as ‘tests of employment’;
how much say your client has on the ‘what’, ‘where’, ‘when’, and most importantly ‘how’ of the work you are doing for them. E.g.: The client controls what hours you work, days you can work, and guide you excessively on ‘how’ to go about doing your work. If the case is such then your contract is likely to be deemed as ‘inside IR35’
Do you need to do the task/work yourself or someone else can be sent in your place to do the task? If you have been specifically hired to do the work and cannot send a substitution in your place to perform the work, you are likely ‘inside IR35’
- Mutuality of Obligation
Is the employer obligated to offer you work? And are you under obligation to accept any work offered by the employer? If obligation stands, then you can be deemed to be ‘inside IR35’.
Other elements that can determine the status of your contracts?
For a contractor to be deemed ‘outside IR35’, they should have complete operational freedom over their work.
Owning your tools and equipment you need to carry out services, rather than them being provided by the client can help your status to be ‘outside of IR35’.
Exclusivity and payment:
Do you have only one client, or do you work for multiple clients? Are you paid on a project basis as a contractor would be? Working for a single client can deem you to be a ‘disguised employee’ and place your contract under IR35.
Having your website, dedicated office space, and having employees can show your image of being a supplier of services rather than appearing as an ‘employee’.
Are you responsible for any errors made during the contract, do you bear the financial risk of rectification on your own time? If so, you can be considered to fall ‘outside IR35’.
HMRC’s’ CEST, or the ‘check employment status for tax’ tool can be used to determine if IR35 applies to a contract, plus there is an IR35 helpline. Experts have pointed out that CEST doesn’t consider the Mutuality of Obligation, a key factor in IR35 case law. Due to the complex nature of the law, contractors should seek advice from an IR35 expert for their contracts.
IR35 reforms or ‘Off-payroll’ tax
On April 2021, there will be an IR35 private sector update that will align public and private sector IR35 rules. IR35 affects all contractors who do not meet HMRC’s definition of ‘self-employment’.
In 2000, when IR35 first came into force, the contractors were responsible for assessing their IR35 status, and determination of any tax or NIC due and IR35 status was the responsibility of the individuals’ limited company or agency.
The rules then changed in 2017 so that, in the public sector, the responsibility for ensuring IR35 is correctly implemented shifted from the contractor to the public sector body engaging them. Responsibility remained with the contractor in the private sector.
In the proposed reform, expected to apply from April 2021, the determination of the IR35 status and paying relevant taxes will be passed from the contractors to the private sector organisation hiring them, previously like in the public sector. This also means that the ‘engaging’ businesses will be held liable should HMRC decide status has been incorrectly assessed.
The IR35 changes in the private sector exclude ‘small’ businesses, however, meaning that contractors working for them will continue setting their IR35 status.
The financial impact of IR35 for contractors
The financial impact of getting caught by IR35 for contractors looking to maximize their income is substantial – they will pay far more tax on their earnings. Determining how much you’ll be able to save by staying outside IR35, is dependent on your understanding of what those extra taxes are.
Contractors outside IR35
A typical, limited company structure is used for payments by contractors outside IR35. Contractors pay themselves a low salary and the rest is paid in dividends or expenses.
This structure results in the following:
A corporation tax on profits, after expenses, will also be paid by the contractor under this structure.
If the contractors’ total personal income (salary + dividends) falls within the higher rate bracket, then the contractor pays further tax.
Contractors inside IR35
Inside IR35, typically use an umbrella company, since it is cheaper than the limited company structure, which provides no real benefits when inside IR35. If the contractor still uses a limited company the tax calculations are the same.
In this scenario, all taxes are fully paid. The only way to minimize tax is to take full advantage of any available expense benefits.
What can you as a contractor do to avoid the financial impact of IR35? – Take Action.
Contractors should get their contracts reviewed by an IR35 expert and seek their legal advice before signing anything. This will ensure you have maximum chances of passing the IR35 review if the need arises.
By channelling pre-taxed income straight into a pension, you can reduce the sting of IR35 with a contactor pension. You can obtain up to 50% tax relief, meaning for every £100 invested your net pay reduces by only £50.