Background to IR35
This piece of tax legislation, named after the Inland Revenue press release which first announced the Government’s plans to clamp down on ‘disguised employment’, was implemented in 2000, and is as controversial today as it was at the turn of the century.
Before IR35 was created, the number of contractors working via their own intermediaries (personal limited companies) was rising at a rapid pace. Limited company owners can enjoy a number of tax benefits which are not available to permanent staff – the main benefit is that no National Insurance Contributions (NICs) are payable on company dividends. Traditional workers have to pay income tax and NICs on their entire salaries.
The Government at the time believed that many limited company professionals were, in fact, ‘disguised employees’, who provided services to their clients in the same fashion as normal employees, and not in the manner of typical ‘self employed’ people who used their own limited companies.
As a result, the Intermediaries Legislation was created to tackle cases of disguised employment. If a person’s contract is deemed to be caught by IR35, the vast majority of their salary will be subject to standard PAYE income tax and NIC rules. The potential tax loss is significant.
Do you fall within the IR35 net?
If you are selected for an HMRC IR35 compliance check, both the wording of your contract, and the way you actually carry out the contract (your working practices) will be examined to determine whether you are ’employed’ or ‘self employed’ for tax purposes.
There are a large number of factors to consider when creating the overall picture of a contractor’s employment status. The key question HMRC asks is: would the individual be an employee were it not for the existence of the intermediary (the limited company)?
Some of the main pointers include:
1. Control – is the contractor under the direct control and supervision of the client?
2. Substitution – is the contractor permitted to provide a substitute if they are unable to work?
3. Mutuality of Obligation – is there the expectation of future contract work when the current one expires?
Alongside these, and other factors, the actual way you perform your contract duties should also demonstrate that you are not a ‘disguised employee’.
Clearly, to almost all contractors, particularly first timers, the IR35 rules can seem daunting, however an entire industry has evolved since the year 2000 aimed at protecting contractors from the IR35 trap.
What is the financial cost of IR35?
If your contracts are caught by IR35, the financial consequences are significant. For example, a typical contractor on £350 per day, working 44 weeks per year, could be over £8,000 worse off if caught by IR35.
Although no changes have been made to the Intermediaries Legislation itself since it was implemented, in May 2012 HMRC attempted to ‘overhaul’ the way it deals with IR35 compliance.
Alongside some typical scenarios, HMRC published a ‘business entity test’ in May 2012, which is supposed to show contractors what potential risk they face of being selected for an IR35 investigation. The test has been widely criticised by many within the contracting industry, as being a missed opportunity to reform IR35, and also for the unrealistic scoring used. You can download the HMRC test here (PDF format).
Additionally, public sector contractor now have to demonstrate that they have complied with their tax obligations before starting work, following a series of scandals in which high ranking officials used limited companies rather than joining the public sector payroll. This obligation includes proving that you are not caught by the IR35 rules.
Thankfully, you are not on your own when it comes to understanding or dealing with IR35.
How to protect yourself from IR35
If you are considering contracting via an umbrella company, then IR35 is not an issue, as you will pay standard tax and NICs on your income.
If you are a limited company contractor, or thinking of setting up as one, you should take steps to mitigate your risk of being selected for an IR35 investigation.
1. IR35 contract reviews – always have your contracts reviewed by an employment status specialist. They will typically examine both the contract wording and your working practices and let you know if you are likely to be caught by IR35. The specialist may be able to provide changes to the proposed contract, and liaise with your agency to put the changes into practice.
2. IR35 insurance – you can also take out tax investigation insurance which will cover the costs of professional representation in the event of an IR35 compliance enquiry. You can even take out cover to protect yourself against any penalties, or back taxes. IR35 insurance tends to be very competitively priced, and certainly less than £200 per year. You can find out more here.