Working Inside IR35 – An Overview

IR35 is one of the most important pieces of legislation as a contractor. Find out how it could affect your take home pay.

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Sometimes due to the contract and specified working practices you may need to work inside IR35. However, this doesn’t necessarily mean you shouldn’t work through a limited company as there are still many benefits.

Obviously there are more tax benefits if you are working outside IR35 (which is fair enough considering the increased burden), however just because a specific contract is inside it doesn’t mean you should immediately turn to an umbrella company solution.

There are still quite a few benefits to operating inside IR35 and working through a Limited company vs using an umbrella company such as:

  • Take home pay should be slightly higher via a Limited company due to extra income gained from the Flat Rate VAT Scheme (click the link for a detailed breakdown of the FRS) which can often add thousands to your annual income, on a £100,000 contract it would add £1,400 extra income. You can’t use the flat rate scheme if you use an umbrella company.
  • You only pay tax on 95% of your income rather than 100% via an umbrella company, HMRC provides for a 5% allowance which is intended to help with the running costs of your company.
  • Umbrella company fees can be the same if not more than accountancy fees, many umbrella companies charge over £125+VAT per month and some even charge a percentage of your contract.
  • Contractors can make use of a wider range of employer schemes such as the use of home expenses, cycle to work schemes, claim childcare vouchers and annual party allowance.
  • Just because this contract is inside it doesn’t necessarily mean other contracts that run concurrently and after, won’t be outside and you will have everything in place.

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Due to the UK’s rather complex taxation system which includes various thresholds plus it’s likely that your expenses will be quite variable which does mean calculating take-home pay isn’t always the simplest of processes. However, these are the various components that affect take-home pay:

  • Invoice value net of VAT
  • Add any Flat rate scheme benefit
  • Deduct 5% from the total (this is to cover the expenses of running your company, if you don’t expense the full 5% you’ll be liable for a small amount of corporation tax at 20%)
  • Deduct any company pension payments
  • Whatever is  left is your salary less employee NI and employers NI

As an example, on a typical £100,000 per annum contract, with roughly £5,000 expenses and £5,000 pension contribution, take home amount will be roughly £65,000 (so around 65%), this is after you take into account the flat rate VAT scheme, employer’s/employees NI, income tax and any corporation tax on profits. Working outside IR35 this amount would be roughly 75% take home pay.

Expenses when inside IR35

When calculating the ‘deemed salary’, certain expenses can be deducted from your contract income. To be clear, the following expenses have been mentioned by HMRC in various consultations and FAQ publications:

  • Travelling (and other expenses deductible under Section 336 ITEPA).
  • Employer contributions to approved pension schemes which attract tax relief in the normal way.
  • The gross salary paid, plus any employer NI contributions on both the salary paid and any deemed payments.
  • 5% of the gross income from relevant engagements to cover running costs.
  • Any other expenses which do not fall within S336 ITEPA, but have another statutory route for a deduction, such as professional subscriptions and professional indemnity or personal liability insurance.
Graphic of suitcase, travel, and cutlery indicating the expenses a contractor can and cannot claim for

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Travelling

You are entitled to tax relief on the full cost of any travelling involved in your contract, or any travelling that you have to do to attend a place at which you are to perform your duties, excluding the costs of ordinary commuting and private travel. For the purposes of contractors, the following logic applies:

  • Workplace - travel from home to your permanent workplace is not tax deductible, this is part of the ‘ordinary commuting’ cost. For many employees their permanent workplace is obvious, and any occasional journeys to other locations will clearly be an allowable expense.

However, in the contracting business, which involves travel to the site of the client, care is needed not to fall foul of the rules. The guidance indicates that a ‘permanent workplace’ is to be interpreted as follows:

“A place where an employee works is a permanent workplace if he/she attends it regularly for the performance of the duties of the employment.” With this definition and the concept of ‘regular attendance’, most contract workers would be in difficulty, but they are excused by the exclusion of temporary workplaces.

  • Temporary workplace - “A workplace will not be a permanent workplace if it is a temporary workplace. A temporary workplace is somewhere the employee goes only to perform a task of limited duration or for a temporary purpose.”

Clearly, this will normally exclude your client’s site, as you attend it for a fixed period only and then the contract ends. This means that you are performing a task of limited duration there and travel to the site will be allowable. However, mindful of possible abuses, HMRC has introduced a limitation to the temporary workplace rule, as follows:

“A workplace cannot ever be a temporary workplace if the employee attends it in the course of a period of continuous work which lasts, or is likely to last more than 24 months.”

A ‘period of continuous work’ is a period of work, throughout which the duties of the employment are performed to a significant extent at that place. For this purpose, ‘significant extent’ will be interpreted as 40% or more of the employee’s working time spent at that place. This limits your deductions in respect of travelling expenses when you renew a contract repeatedly.

If you would like to have your contract reviewed please take a look at our IR35 Contract Review Service.

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