Understanding IR35

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IR35 wasn’t always a concern for contractors: when I started my first contract in the 90s, 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 director, I knew it 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 is IR35?

Why was IR35 introduced?

In the 1990s, as the contracting industry boomed, the number of contractors working via their own limited companies increased exponentially. 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 gain the tax benefits that a company provides. Essentially, doing the same work as before, but not via the company payroll. There’s no National Insurance to be paid on company dividends, so limited company contractors pay less tax than traditional employees, who pay National Insurance on their entire income.

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.

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.

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What if I’m caught by IR35?

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 (your contract is ‘outside’ of 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 people who have worked on contracts inside of 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.

The number of people selected for HMRC compliance checks is actually very small, especially considering the amount of uncertainty IR35 has created.

Despite this, IR35 seems to make some behave irrationally. Some people would rather accept that they’re ‘disguised employees’ and have a contract voluntarily fall inside of IR35.

From my experience, I’d say that all contractors should take active steps to determine theIR35 status of a contract, and if they are likely to fall foul of the IR35 rules, they should seek professional advice.

How much tax do I pay under IR35?

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.

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. And you can currently deduct 5% of your turnover for running your company.

Your income will be subject to the same level of tax as an employee, including National Insurance contributions. For more information about calculating your pay if you’re inside IR35, read our guide here.

How do I remain outside IR35?

The first thing I do when starting a new contract is send 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.

You also need to show that you are working in a different way to 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’.

You can find out more about how to structure your working practices in our comprehensive guide to IR35.

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