What is IR35?
IR35: it’s likely that as a contractor, you’re all too familiar with the legislation. But do you know just what it is, what it means to be inside and outside of IR35, and how being inside could impact your contract? We’ve answered all with our guide.
What is IR35?
IR35 is a piece of tax avoidance legislation that came into effect in 2000. It was designed to ensure that contractors working as disguised employees paid the same tax as an employee.
For example, an IT worker may resign from their permanent role on a Friday but return on Monday doing the same job, at the same company, at the same desk with the same manager. The only difference is they are now doing the job as an IT contractor working through their own limited company, and benefiting from tax reliefs available to small business owners.
What is inside and outside IR35?
Essentially if you have the same benefits and responsibilities as a permanent employee, then you would more than likely be classed as inside IR35 (caught by IR35). Some of the key factors that determine if you’re inside or outside IR35 are right of substitution, mutuality of obligation, and control.
It is best to remember that unless HMRC decides to open an IR35 investigation they will not want to see your contract, however, it is important that your working practices must reflect what is in your contract. You'll also need to be aware that you’ll read all sorts of information about IR35 and urban myths are common, many of which aren’t true, so it is always best to seek professional advice.
As you might have heard there is much controversy over the implementation of IR35. Primarily because there's no clear definition of what an employee is, so we need to rely on case law. Each contract and its circumstances differ wildly.
What does it mean to be outside IR35?
Due to the increased work, risks and responsibility, there are advantages of working through your own limited company. In addition to the freedoms of working for yourself, you can benefit from the tax advantages available to all small business owners. For example, you will be able to claim tax relief on legitimate business expenses and structure your pay in the most tax efficient way. For example, dividend payments (profits taken from your company) do not attract National Insurance Contributions.
However, if your working practices are viewed to be too similar to an employee, (the level of control and an emphasis on personal service, for example), then it’s likely that your contract will be classed inside IR35.
Some of the key factors that determine if a contract is inside or outside IR35 are:
- Control - how much control do you have over how, when and where you complete the work? If you have a high level of control over the work you complete, this would indicate a position outside of IR35.
- Substitution - can your company send in a suitably qualified person to complete the assignment. Or must you do this personally? Personal service is a hallmark of employment.
- Mutuality of Obligation – are you obligated to accept further work from the end client? Do they have an obligation to continue to offer you work? If so, this will indicate an employment type relationship.
- Financial risk - to what extent are you personally liable if anything goes wrong?
- Provision of equipment - (sometimes, especially insecure sites you may have to use a client-side-equipment) how much of your own equipment do you purchase and use for a contract?
- Part and Parcel - are you treated the same on a day to day basis as your end clients’ employees?
If your contract is deemed to be inside IR35, it effectively means that you are treated as an employee for tax purposes and are liable for PAYE tax. When you work inside IR35, you will lose the ability to claim tax relief on expenses relating to the assignment.
How to be sure your contract is outside IR35
The best way to get certainty for your contract’s IR35 status is to undertake an IR35 contract review.
This will determine whether your contract falls inside or outside of IR35 and if applicable whether changes should be made to your contract or working practices. If it’s likely that it will be deemed inside, your accountant can make practical suggestions about how to structure your business.
An effective way to help you stay protected is to enlist the help of a specialist accountant. An accountant can provide ongoing support when it comes to structuring your working practices, can deal with HMRC on your behalf and can offer you invaluable insight.
How much tax do I pay under IR35?
If HMRC decides to conduct an IR35 investigation, they will review the working practices of the individual through a number of employment status tests to work out whether the contractor is truly in business on their own account or a disguised employee.
It is still worth working via a limited company even if a contract is inside of IR35, as there are benefits to be gained from joining the Flat VAT Rate Scheme. You can still benefit from setting up an executive pension scheme. You can also currently deduct 5% of your turnover for running your company for assignments within the private sector.
Things are different for public sector assignments where it is the responsibility of the end client to determine the IR35 status of the contract. For these engagements, the fee-payer (the entity that makes payment to your limited company) will be responsible for making deductions of PAYE Tax and National Insurance and paying the net payment into your business bank account. This can then be withdrawn with further charge to tax.
In April 2021, the same rules came into effect for engagements with medium and large companies in the private sector. Read more about the reforms to off-payroll working.
Your income will be subject to broadly the same level of tax as an employee, including National Insurance contributions.
You should also be aware that you will read all sorts of information about IR35 and urban myths, many of which aren’t true. So it is always best to seek professional advice. Due to changes in legislation, it’s important to remember that the information you read could be outdated. With the introduction of the public sector reforms in 2017 and the incoming reforms to off-payroll working in the private sector this is likely.
It’s also worth noting that even if your contract is caught inside IR35, it may still be beneficial for you to work through your own limited company. An accountant can help to advise on the best option for you.
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