As a contractor operating through a limited company you will have no doubt heard of IR35 legislation already. If you’re a sole trader, you can breathe a sigh of relief as you’re unaffected.
IR35 was first announced way back in 1999 in a seemingly innocuous press release by the Inland Revenue (now HMRC). The press release was titled IR35 and that has become the common vernacular for this legislation ever since.
IR35 became law in 2000 and since then there have been various overhauls, delays and reforms – not to mention a cancelled repeal which you may remember from the September 2022 Mini-Budget – to address issues, negativity and uncertainty surrounding the IR35 rules..
Over the 24 years since its inception, IR35 has turned out to be one of the most significant and controversial pieces of tax legislation the Government has introduced.
In this post we’ll break down what IR35 is, how it impacts contractors as well as tips and advice.
What is IR35?
IR35, also referred to as ‘intermediaries’ legislation, is a tax law that applies to contractors operating through their own limited company. It’s designed to close a loophole known as ‘disguised employment’ whereby an employee would class themselves as self-employed to benefit from the tax advantages that self-employment through a limited company presents.
The ultimate aim from the Government’s perspective is to eliminate tax avoidance by clamping down on disguised employees, close the tax gap and promote fairness by ensuring that everyone pays the right amount of tax.
Your IR35 status can fall into one of two categories: inside or outside IR35 which effectively mean that you’re either deemed employed or self-employed.
What does Outside IR35 mean?
Being outside IR35 is the ideal scenario for limited company contractors. As a contractor operating outside IR35, you are considered by HMRC to be genuinely self-employed. You receive gross payment for your services and are then responsible for paying your own tax and National Insurance liabilities which you pay to HMRC directly by way of self-assessment tax returns. You also have control over how you structure your remuneration.
What does Inside IR35 mean?
If you’re deemed to be inside IR35, HMRC views you as an employee of your client(s) rather than genuinely self-employed, assuming that your client is a UK-based medium/large entity. They’re classed as a medium/large entity if they exceed 2 of the 3 criteria below:
- 50 employees
- £10.2 million turnover
- £5.1 million balance sheet total
Small business exemption rules may apply, however, if your client doesn’t meet 2 of these criteria and we’d recommend that you contact us if you’re unsure.
When you’re inside IR35 you must pay tax and National Insurance contributions the same way a conventional employee would, with your tax liability deducted at source by your employer through Pay As You Earn (PAYE).
How is your IR35 Status Determined?
Before April 2021, it was the responsibility of the contractor to determine their IR35 status. The Government then introduced the private sector “off-payroll working rules” IR35 reforms and from April 2021, the responsibility to determine IR35 status sits with the client or hiring company that pays the contractor. If the client deems that the contractor is an employee – inside IR35 – then their taxes will be deducted at source through PAYE.
From HMRC’s perspective, this change made sense as it’s financially beneficial to contractors to be outside IR35 and, as such, they have a vested interest in that outcome.
If you receive employment benefits like a permanent employee and are managed like a permanent employee, it’s likely that you’re inside IR35. If you work through and are paid by your own limited company and aren’t under the direct supervision and control of your client, you’ll likely be outside IR35.
There are other factors to consider, however, including the right of substitution. If you’re allowed to provide a substitute to work on the contract other than yourself, you’d be considered outside IR35. If you can’t provide a substitute, that indicates there’s a contract of employment and you’re likely to be inside IR35.
Mutuality of obligation is also a consideration. If there’s an expectation of future work after your contract expires that is an indicator to HMRC that you’re inside IR35. As a self-employed contractor, your contracts have a defined start and end date with no expectation of future work, and that means you’re outside IR35.
HMRC’s CEST Tool
You can use HMRC’s Check Employment Status for Tax (CEST) tool to help determine the IR35 status of a contract.
How does IR35 affect you as a Contractor?
IR35’s impact on you as a contractor can be significant, both in positive and negative ways, depending on your status.
The most significant impact of IR35 is on your earnings and the way you are affected depends on whether you’re inside or outside. If you’re inside IR35, your tax liability will generally be higher which means reduced take home pay.
When you’re a contractor outside IR35 and operating through a limited company, you can structure your remuneration through a combination of salary and dividends to reduce your overall tax liability which can help you to retain more of your earnings while remaining compliant.
There are other financial effects too. When inside IR35 it’s likely that you can claim fewer expenses which can increase your overall tax liability. Higher pensions contributions might also be necessary which can have a detrimental effect on retained earnings.
A key benefit of being self-employed is the level of control that you have, but when inside IR35 you are effectively managed by your client and as such, have less autonomy because your work is controlled and supervised. Some contractors might be comfortable with this but for others that have worked outside IR35 for a long time, it might be an issue.
IR35 Contractor Tips
IR35 can be both confusing and frustrating for contractors, but increasing your understanding of the rules and being proactive about determining your status can be a big help.
Thoroughly Assess Your Contracts
By assessing both your working arrangements and contracts with your clients, you can help to remain compliant. It’s important that they both reflect the services that you provide and the way in which your relationship with the client is managed. Potentially you may need to make adjustments to your working arrangements to remain outside IR35 and keep yourself compliant.
Determine Your IR35 Status
By being proactive to determine the IR35 status of your contracts, you can get ahead of the curve. As part of their determination whether the contract is inside or outside IR35, your client should provide you with a Status Determination Statement which breaks down why they have reached their decision. Ideally you want to be outside IR35 so if they have determined you are inside IR35, you are able to challenge this. Being diligent about your IR35 status can help in this regard.
Be Ready for a Tax Increase
If you are found to be inside IR35, it’s likely that you will have to pay an increased rate of tax and National Insurance contributions. It’s important to be prepared for this so it’s a good idea to set aside some funds just in case.
Get Professional Advice
IR35 has caused a high level of change and uncertainty for contractors. The stakes are high with potentially reduced earnings should you be inside IR35, not to mention strict regulation and the possibility of an investigation and penalties for non-compliance.
But with challenge comes opportunity, and contractors should view IR35 as a challenge to be embraced. It’s an opportunity to review your working practices, ensure that your tax affairs are in order, both in terms of compliance and optimisation, and take the necessary steps to help your business thrive.
We understand that it’s not always easy to determine whether your contracts lie inside or outside IR35. With grey areas in the rules and so many factors to consider, contractors often seek specialist help to determine their position.
This is why Gorilla Accounting has partnered with Qdos to provide expert contract reviews. If you’re concerned about your contractor IR35 status, contact us today on 0330 024 0406 or request a call back here to speak to an expert IR35 accountant.
