What is IR35?
First introduced by HM Revenues and Customs (HMRC), IR35 – which is also known as Intermediaries Legislation – is a piece of government tax legislation established to reduce tax evasion amongst workers. The purpose of it is to close a loophole in the tax system whereby workers could utilise the setup of a limited company structure to pay less tax.
Specifically, it challenges contractors who work in a similar way to full-time employees but charge for their services via their limited companies in order to make their business as tax efficient as possible – they are referred to as disguised employees. IR35 rules are designed to ensure that contractors who work via their limited companies (and are therefore deemed to be completing the same work of an employee) pay the same/correct tax.
However, due to the subjective nature of the legislation, it is heavily criticised by tax experts and the business community for being poorly conceived, badly implemented, and causing unncessary costs and hardships for legitimate small businesses.
Why Was IR35 Introduced?
Before IR35 was introduced, it wasn’t uncommon for contractors to exploit the tax system by leaving their employment positions to create a limited company. They would then return to the same role but in a contracted relationship and thus benefit from the tax advantages of a company setup – contractors using a limited company can take the majority of their earnings in the form of dividends, which is taxed at a lower rate than income tax.
This, however, is considered a form of tax avoidance as they were seen to be bending the rules of the tax system to gain an advantage.
Since the legislation has been enforced, contractors judged to be employees (known as ‘deemed employees’) are required to pay tax at the equivalent rate to employees. Deemed employees don’t, however, get access to any of the benefits typical employees are entitled to, such as sick pay, company pensions or holiday entitlement. This is another reason why IR35 is often criticised and viewed as unfair.
What Does it Mean to be Outside IR35?
If you are deemed to be outside IR35, you are considered self-employed for tax purposes. You are responsible for ensuring you pay the correct taxes on time and are free to pay yourself in the most tax efficient way.
What Does it Mean to be Inside IR35?
If you are deemed to be inside IR35, you are considered an employee for tax purposes. You are taxed in the same manner as a permanent employee so are required to pay tax at the same rate as an employee in the same tax bracket.
Am I Inside or Outside IR35?
As a rule of thumb, IR35 won’t apply if the contract is for the services you provide rather than employment. It’s always recommended that you take professional advice, but to help decide if your business falls inside or outside of IR35, consider the following –
Are you required to carry out the work yourself or can you send someone in your place? If a contract states that it must be you to complete the job, then this working relationship will fall inside IR35.
Mutuality of Obligation
Is your client obliged to offer you work and are you obliged to accept it? For example, if your client is obliged to offer you paid work and you’re obliged to take it, you fall within IR35.
Supervision, Direction and Control
To what degree of supervision, direction and control does your client have over what, how, when and where you complete your contract and day to day work? Contractors must have control over how they complete their work for a contract to fall outside of IR35.
It’s important that you comply with IR35. If HMRC discovers that you have been working outside IR35 (on a self-employed basis) when in fact the service you provide your clients reflects that of employment, you’ll be made to pay the missing tax back to HMRC plus interest (usually circa 25%) and any penalties.
It’s worth noting that HMRC can investigate as far back as 6 years. Being found non-compliant can have significant financial consequences.
IR35 Changes 2020
Initially, IR35 employment status was declared by the contractor. However, in 2017 the rules changed for the public sector so that the onus of proving self-employed status was now on the hiring organisation. This inevitably made hiring contractors a risky business as the hirer would be fined if they incorrectly identified an IR35 contractor as an ‘outsider’.
Private sector IR35 reform is set to come into effect in April 2020. The public sector rules explained above will also be applied to the private sector, meaning that private sector employers hiring contractors will now too be responsible for determining their IR35 status.