Understanding IR35

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When I started my first contract 15 years ago, my main task (aside from getting used to my new job) was to find a good accountant to take care of my tax affairs. The market was good, there was plenty of work about, and as a limited company contractor, I knew this was the most tax efficient way to work.

However, at the end of my first year of contracting, in 1999, there was a lot of concern within the industry about proposed Government plans to increase the tax burden on contractors who were working via limited companies, but still working like ‘employees’ for their clients.

And in April 2000 the Intermediaries Legislation (a.k.a. IR35) was introduced, which brought much confusion to the market. I had so many questions, how would this affect me? Do I need to do anything? But quite simply I wanted to know exactly what IR35 is?

I could have used a simple, easy to follow guide to IR35 when it first became law, so I hope you can benefit from my experiences, which I’ve shared with you here.

Why was IR35 created?

In the 1990s, as the contracting industry boomed, the number of contractors working via their own companies increased significantly.

The Government believed that large numbers of workers were leaving their permanent jobs one day, only to return as limited company contractors shortly afterwards – this is where the phrase ‘disguised employee’ comes from.

It’s a term used by the powers that be to describe limited company workers who carry on working in the same way as employees, but gaining the tax benefits that a company provides – doing the same work as before, but not via the company payroll.

Of course, there’s nothing wrong with becoming a contractor – quite the opposite, however, tax lies at the heart of the Government’s concerns.

Put simply, there’s no National Insurance to be paid on company dividends, so limited company contractors pay less tax than traditional employees, who pay NI on their entire incomes.

This seems to be a fair deal. Personally, I take a risk in running my business. There is less certainty about where my next contract work is coming from, compared to permanent employees. I often work beyond my contracted hours and have none of the perks associated with permanent work – such as pension contributions, sick and holiday pay. So, I – along with all the other contractors I’ve met over the years – feel that there should be a marginal tax benefit available to limited company contractors to redress the balance.

In the late 1990s, the Government felt that it was unfair to have contractors doing the same work, in the same conditions as permanent employees – but paying less tax due to the limited company intermediary. This is why the IR35 legislation was introduced.

If HMRC decides to look at a contract they will review the working conditions of the individual through a number of ‘employment status’ tests to work out whether the contractor is ‘self-employed’, or merely a disguised employee.

If you’re not caught (i.e. you are ‘outside’ IR35), life carries on as usual. However, if your contract is found to be ‘inside’ IR35, your income will be taxed in the same way as a permanent employee (subject to a small allowance for the costs of running a company).

I know a few contractors who have been caught by IR35, and the benefits of being a limited company contractor have been reduced – mainly because they now have to take their income in the form of a deemed salary, which is taxed in a similar way to permanent employees.

It is still worth working via a limited company even if you are caught by 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, and you are allowed to deduct 5% of your turnover for running your company.

So, what factors influence your IR35 status?

When I started out as a contractor, I thought I could figure out whether my contract is inside or outside of IR35, however, I soon found out this was unrealistic (I’m not a legal expert after all!), and asked my accountant to review my contract. Your recruitment agent may be another initial point of contact if you’re looking to be pointed in the right direction towards a professional contract review service.

When a professional review your contract, they will establish whether or not you’re working in a ‘self-employed’ way – according to a number of factors.

There are many factors to take into account. I’m not going to go into those here, as this would end up reading like a complex (and tedious) tax periodical!

These factors are meant to show to what extent you run a business ‘on your own account’ – you take financial risks, you have some control when and where you work, you can provide a substitute if you’re ill, and so on.

But remember, the wording in your contract, combined with the way you actually carry out the work determines your risk from IR35.

There are several professional resources for IR35 available online, and your accountant and /or IR35 expert will be able to provide you with all the detailed information you need.

What steps to take to remain IR35-free

The number of people selected for HMRC compliance checks is actually very small, especially considering the amount of uncertainty IR35 has created and the chances are, your contracts won’t be caught by IR35 either, thanks to the professional help available these days.

Despite this, IR35 seems to make some people behave irrationally. Some people would rather accept that they’re ‘disguised employees’ and simply voluntarily fall within the scope of IR35.

One guy I know tells me that he “can’t be bothered with IR35”, so opts to pay significantly more tax by using an umbrella, even though I’ve told him many times that with a bit of expert help and reassurance, he would realise that IR35 wouldn’t be an issue for him.

A number of others have made no effort whatsoever to comply with IR35 – even deciding not to have their contracts reviewed by a professional.

I’m perhaps in a fortunate position, as I’ve spent a lot of time getting to understand IR35, and working with some of the leading employment status experts.

From my experience, I’d say that all contractors should take active steps to determine their IR35 status, and if they are likely to fall foul of the IR35 rules, they should seek professional advice.

IR35 contract reviews

The first thing I do when starting a new contract is sent it to an employment status expert for analysis. This is surprisingly inexpensive – under £100 in most cases. Some will even carry out free verbal IR35 reviews if you’re after a quick scan.

With the service I used in the past, I’d send my contracts over via email, and an advisor would go through the wording to establish which clauses needed further attention before they could be viewed as ‘IR35 friendly’.

In some cases, the service includes liaising with your recruitment agent, to ensure that the wording on the contractor-agency contract also mirrors the wording on the contract which is signed between the client and the agency.

As I mentioned earlier, it never fails to amaze me how many of my colleagues and contacts think that merely rewording a contract will mean you are protected from IR35.

The contract must reflect the reality of the business arrangement you have with the client, and the wording itself is only half of the obstacle.

You also need to show that you are working in a way more similar to a self-employed person, rather than a typical employee.

This includes showing that you have some control over the work you carry out for the client (you’re not simply being told exactly what to do all day).

Although it may never happen in reality, the right to provide a substitute person in your place if you’re unable to work is also important.

These and other factors should be highlighted during the contract review process.

When I had my first contract checked for IR35, I must admit that I found the whole topic a little confusing – there was a long list of things I had to change – both in terms of the contracting wording, but also relating to my ‘working practices’.

Final Thoughts

If you’re concerned about IR35, don’t worry – you’re not alone.

By taking my accountant’s advice, and keeping on top of changes to the legislation over the years, none of my contracts has been caught by IR35.

IR35 has been almost universally criticised by tax and industry experts ever since its implementation.

It’s still the biggest topic of conversation (aside from the state of the contract market) when I talk to my friends about contracting issues.

If you follow the basic steps I’ve discussed here, you should be able to live with IR35, as thousands of others do, whilst remaining outside of its scope.

My advice would be to ask your accountant for their advice in the first instance and check the leading contractor sites for the latest updates on how IR35 is administered.

You may also find our free Guide to IR35 useful. Alternatively for more information on IR35 or getting a contract reviewed speak to a member of New Business Team on 01442 275789 or email newbusiness@sjdaccountancy.com.

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