What is IR35 and why should you be aware of it?
As a contractor, understanding IR35 and what it means is crucial for your business. Also known as ‘intermediaries’ legislation’, IR35 first came into effect on the 6th of April of 2000 and is designed to prevent contractors from working as disguised permanent employees and benefitting from tax advantages by working through an intermediary, such as a limited company.
Getting the best IR35 advice is key. At Gorilla Accounting, we aim to help you navigate this complex – and often confusing – legislation to ensure you don’t get caught in it. Our ultimate IR35 guide below can help you to gain a deeper understanding of this subject and why you need to know all there is to know about it.
What is IR35?
Firstly, it’s important to know exactly what this tax legislation is in order to know if and how it can impact you. The legislation can be boiled down to a simple question: are you a full employee or a genuine contractor?
IR35 was implemented to fight tax avoidance by workers who are supplying services via an intermediary, like a limited company, but who would be considered an employee if this intermediary wasn’t used. These ‘disguised employees’ are not considered self-employed by the HMRC and are to be taxed the same as a permanent employee.
Before this legislation was introduced, a self-employed worker was able to provide services to clients as a one-man limited company, receiving a large part of earnings and dividends but saving on National Insurance and tax deductions.
Controversy surrounding IR35
This tax legislation, named after the Inland Revenue press release that announced the Government’s plans to come down on ‘disguised employment’, is just as controversial today as it was back in 2000. IR35 has been opposed by several bodies since its inception. After all, HMRC doesn’t make it easy to tell contractors and employees apart, so there are a variety of questions you need to ask yourself in order to gauge your status. There is also no definitive rule to IR35, which further complicates your assessment.
One of the most famous and fiercest opponents is the IPSE, a contractor and freelancer representative group; the organisation sought a judicial review of the legislation in early 2001. Although the group lost the appeal, many businesses continue to argue against IR35 to this day, believing that its rules are unfair and too ambiguous to provide any concrete certainty.
Combatting the legislation has proven fruitful for some. The HMRC recently lost an IR35 case, after an IT contractor fought against a £27,000-plus tax bill successfully; interestingly, the same contractor won another IR35 case back in 2004. So, while the HMRC has won several cases since 2000, so have taxpayers.
There are, however, many arguments in favour of IR35, as well. These include:
- It’s unfair for two workers performing the same tasks to pay different rates of income tax and national insurance if there’s no difference between working arrangement. The legislation can help to even the field.
- In order to avoid paying the correct income tax and national insurance, some workers will leave on Friday as an employee and return on Monday to do the same job as a hired consultant; these “Friday to Monday” cases can be prevented via IR35.
Who can be affected by IR35?
It helps to know who exactly can be impacted by the IR35 legislation. After all, you may think you are inside IR35 but find out you aren’t; or vice-versa. Until very recently, only contractors were responsible for establishing their IR35 status. After 2017, reforms in the public sector meant the following:
- Hirers can determine the IR35 status of contractors.
- Agencies are responsible for deducting tax from contractors’ pay.
- Agencies risk being liable for unpaid tax and penalties if the worker is inside IR35.
Intermediaries are typically defined as limited companies, personal services companies or partnerships. However, IR35 rules may also be enforced when working through intermediaries that are abroad or in construction, when working with a spouse or partner, and when working for a charity.
The HMRC estimates that the IR35 reform in the public sector has generated £410 million in additional revenue for the Treasury so far and that almost 86% of contractors have been affected by it.
Are you inside IR35?
How do you know if you’re inside the legislation?
IR35 is determined through several acknowledged status tests based on historical case law which are applied to your written contract and working practices.
If you’re a contractor, freelancer or consultant who’s in business on your own account, then IR35 won’t apply to you. It’s still important to be aware of the legislation and any potential changes to it, of course, since you may have to prepare a defence if the HMRC wishes to investigate.
If you, on the other hand, possess the same benefits, responsibilities, and control as a permanent worker, then it’s highly possible that you’re inside IR35.
There are several pointers you can keep in mind to check whether or not you’re a self-employed contractor and are inside IR35, such as the following:
- Control – are you under the direct control and supervision of your client? A contractor is not supervised like an employee is.
- Substitution – are you allowed to provide a substitute if you’re unable to work? If not, then HMRC would consider this to be an indicator of a contractor of employment.
- Mutuality of obligation – are there any expectations of future contract work after the current one expires? A self-employed contractor will work on a specific project that they’ve been contracted to do but there should be no further expectation of work by either side.
- Provision of equipment – do you use equipment provided by the client or do you use your own? Contractors generally possess their own equipment, while employees will have all major pieces of equipment and facilities provided by their employer.
- Payment – self-employed people are usually paid by the job and not by a fixed hourly/daily rate.
- Doing other work – this is a major pointer in determining whether or not someone is an employee; if a contractor has the right to work for other clients, then they’re self-employed.
- Being in business – contractors typically have their own website and business insurance, which employees do not.
- Contract termination – notice periods are reminiscent of an employee-employer relationship, so IR35-friendly contractors tend to not have them.
- Financial risk – if a contractor does something wrong, they have to correct that mistake at their own cost and should not be paid for the additional work.
What does it mean to be inside IR35?
The idea behind IR35 is to prevent individuals from acting and being treated as employees of a company when they aren’t. After all, doing so would mean they’d have the right to all the benefits and tax breaks that employees under limited companies are entitled to.
If you’re found to be within IR35, you will have to pay income tax and National Insurance Contributions (NICs) as if you’re employed. This will have a significant financial impact; being caught in this tax legislation may reduce your net income by up to 25%, costing you thousands in additional income tax and NICs. If you’re in the public sector, you can only claim on a limited number of expenses and won’t be entitled to the HMRC’s 5% expense allowance.
In addition, IR35 can look at the last six years and analyse your past contracts as well; if the legislation applies, then you incur penalties and interest, in addition to more income tax and NICs.
These are just some reasons why it’s important to be aware of IR35 and how it can impact your finances.
If you’re caught by IR35 and deemed to have the same responsibilities or benefits as a permanent employee, your earnings for a specific job are also considered the same as a full-time worker. You’ll have to pay a ‘deemed payment’ at the end of the tax year to account for any deductions or NICs that a permanent employee would have paid. If you’ve paid enough in national insurance contributions and PAYE, then it may not be required that you make this payment.
Many people worry that they’re doing something illegal by being caught by the legislation; however, this couldn’t be further from the truth. Being caught by IR35 is considered tax avoidance, not tax evasion, which is illegal. The ambiguity and uncertainty that the legislation offers are likely not of any help if you’re worried about it; a professional adviser will be able to help you navigate this tricky issue, answer any questions you may have and put your mind at ease.
How should you operate as a contractor?
Because there’s a lack of clarity when it comes to IR35, it can be a challenge to decide which operating structure to choose. If your assignment is considered to be inside IR35, then working under an umbrella company may be the most tax-efficient path; this isn’t always true, as it will depend from case to case.
Higher paid contractors, for instance, may find it more beneficial to operate through a limited company. And even if your contracting job falls within IR35, you may still choose to operate as a limited company; if you have contracts outside of the legislation, they can be put through the limited company.
Seeking the services of a company that specialises in contractor accountancy can help you to figure out how to operate. A contractor tax calculator is also a useful tool to know your take-home pay.
Change is coming – IR35 in the private sector
As expected, during the Autumn Budget 2018 statement, Chancellor Phillip Hammond stated that IR35 is coming to the private sector, as well. The changes will be introduced in April 2020. After that date, the responsibility of confirming the IR35 status will shift from the employee to the agency or end client; if the employee is caught by IR35, the agency or end client will also be accountable for tax and national insurance deductions.
These new changes will only be applied to medium or large organisations, while small ones will be exempt. The Chancellor said: “The off payroll working rules – known as IR35 – are designed to ensure fairness so that individuals working side by side in a similar role for the same employer pay the same employment taxes.”
How can contractors and freelancers prepare for the upcoming IR35 reform in the private sector? Even though all the details still haven’t been fleshed out, there are several ways you can start preparing, such as:
- Taking the HMRC IR35 test, which will allow you to assess your current business practices.
- Auditing your work practices after the HMRC’s test results; this will allow you to analyse how IR35 changes may affect your business and how to solve potential issues.
- Seeking expert advice, such as through Larsen Howie. Before you make any changes, you may want to get professional advice to ensure that you’re on the right path. Likewise, if you’re still unsure whether or not you’re compliant with IR35, finding a company that specialises in this and other work legislation will help.
Gorilla Accounting can help
If you’re worried about IR35, especially with the new looming reform, you’re not alone. Many contractors struggle to understand all the ins and outs of this legislation, which can be perplexing. However, the basics of IR35 legislation should be understood by every contractor in the UK since its rules can seriously impact your take-home pay if you get caught in it. It’s important, therefore, to seek advice from professional contractor accountants who specialise in IR35 and all its ramifications.
Gorilla Accounting are here to answer all of your IR35-related questions. We can help you to protect yourself against IR35 and help you to mitigate the risk of being selected for an investigation. We can put you in touch with an IR35 review specialist who offers a discounted service to all Gorilla Accounting clients.
As a contractor, peace of mind is important in running your business, so we aim to take the stress away from paying taxes. Talk to our expert team of contractor accountants and we’ll be more than happy to help with any questions you may have; and will deal with any tax-related queries for you.