What does working inside IR35 mean?

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Most contractors know that working inside IR35 results in being taxed at a higher rate. However, what’s often glossed over is the specific tax which you’ll be required to pay, along with the other financial implications, should you be classed as an ‘employee for tax reasons.’

When IR35 reform is introduced in the private sector on 6th April 2020, medium and large businesses will become responsible for setting a contractor’s IR35 status. While HMRC hope that many of these companies will be ready and capable of making accurate status decisions by then, there is a risk that you could have your tax status set incorrectly. Therefore, it’s crucial you have a firm understanding of how working inside the legislation would impact you.

Before we get started, we’d like to dispel the myth that working inside IR35 is not allowed and is not compliant. It is. You will, however, be taxed more, given that contractors operating inside the rules are considered employees for tax purposes. In simple terms, this means the service you provide is deemed to reflect a service of employment, not self-employment.

PAYE taxes

If your contract is caught by IR35, you will be required to pay income tax and National Insurance Contributions similar to an employee in the same tax band. Assuming you’re placed inside IR35 from (which by no means is a given), the fee-paying party in the supply chain will deduct these taxes before paying your fees.

While operating inside IR35 results in a contractor paying extra tax, in the public sector currently and upon the arrival of private sector reform, you can at least take comfort in the fact that you will not need to organise and pay these to HMRC yourself. Your client or recruitment agency will do this on your behalf.

However, until these changes are introduced in the private sector, and assuming that you work inside IR35, you will need to calculate a ‘deemed payment’ and remain responsible for making sure the correct amount of tax is paid to HMRC. It’s also important to note that contractors working with clients that fall under the taxman’s definition of ‘small’ will retain the right to set their own tax status from next April.

Limited expenses

As a contractor working inside IR35, you cannot claim the same expenses that you can when working outside the rules. HMRC’s allowance is very strict indeed. In 2017, the taxman introduced changes which mean that travel and subsistence expenses, like mileage, accommodation, meals and other ad-hoc costs, are not legitimate on inside IR35 contracts. Should HMRC find that you have claimed these expenses while working on a contract caught by the rules, they will not be tax deductible.

This, in addition to the fact that operating under IR35 results in higher taxes, has led to discontent among contractors, many of whom struggle to see the benefits of working inside the legislation.

5% allowance to be scrapped

As was the case in the public sector following IR35 changes, the 5% expenses allowance, which was granted to contractors for administrative and accountancy costs when calculating the ‘deemed payment’, is likely to be scrapped from April 2020 in the private sector. This is because the fee-payer will carry the responsibility for working this out, not the contractor.

While the advantages of operating inside IR35 are limited in contrast to working outside the rules, it’s worth bearing in mind that you can simultaneously work on other projects that are not caught by the legislation. And should a contract fall within the boundaries of IR35, it has been reported that a number of independent professionals are considering raising their day-rate to accommodate the extra cost.

If you’re placed inside IR35 from April 2020 in the private sector, it’s important to remember that you are also well within your rights to challenge the decision, should you feel it is inaccurate. A smart way to go about doing this is by having your contract reviewed by an expert, who will be well-placed to advise whether your working engagement falls inside or outside the legislation.

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