IR35, it doesn't have to be complicated. We've broken it all down, so you don't have to.
If you're a contractor, thinking about becoming one, or run a business hiring contractors, it's important to know about IR35. Here, we explain the rules in simple terms and what they mean for you.
Contractors who work for themselves through a limited company can get tax benefits, but IR35 changes how they can do this legally. IR35 aims to make sure that contractors who work like regular employees pay the same taxes and National Insurance to prevent tax avoidance.
IR35 has been in the news a lot lately due to significant changes. It's a big deal for self-employed individuals, as those under IR35 have to follow different tax rules.
What is IR35?
Also referred to as the 'Intermediaries Legislation,' IR35 is HMRC's way of defining off-payroll working. This UK tax law aims to spot contractors and businesses that try to avoid paying the right taxes by either acting as 'disguised' employees or hiring workers on a self-employed basis to hide their true employment status.
IR35 came into effect in April 2000 and got its name from the initial press release by the Inland Revenue (now HMRC) announcing its establishment.
IR35 and working as a contractor
IR35 rules are closely tied to contracting work. If you're a contractor operating through a limited company, you can pay a 19% corporation tax on profits below £50,000. You also get the benefit of claiming business costs against your tax and avoiding National Insurance Contributions (NIC) by paying yourself through dividends.
This makes working as a contractor often a more tax-efficient setup compared to working through an umbrella company or as an employee. Some contractors, operating similarly to employees, intentionally or unintentionally gain a tax advantage over others.
The government aims to eliminate this advantage using IR35, increasing overall tax revenue. This means that IR35 could have significant implications for owners of limited companies.
Since the reforms in April 2021, clients are now responsible for determining the IR35 status of contractors in both public and private sectors, except for small businesses in the private sector. In these cases, contractors need to figure out their own IR35 tax status.
What does inside IR35 mean?
Being 'inside IR35' means, according to the IR35 legislation, you need to pay taxes similar to an employee. This might also grant you additional rights, such as minimum wage, maternity pay, and protection from discrimination.
If you're determined to be working inside IR35, you typically have to settle a 'deemed payment' of income tax at the end of the tax year, covering any tax deductions or National Insurance Contributions (NIC) similar to what an employee would pay.
What does outside IR35 mean?
Being 'outside IR35' means that the IR35 legislation allows you to continue the tax setup mentioned for private contractors. This enables you to pay yourself a salary and take additional income as dividends (which don't have National Insurance Contributions). Meanwhile, your limited company can be taxed at the 19% corporate rate if your profits are under £50,000.
Signs that you are outside IR35 and operating like a business include having your own business insurance, promoting yourself through a professional website, owning your equipment, and working for multiple clients.
If you're a contractor, it's advisable to seek detailed advice on your IR35 status. An IR35 assessment can evaluate both your service contracts and day-to-day working practices.
Key IR35 changes explained
When IR35 was introduced in 2000, each contractor was responsible for determining their own IR35 status. The individual's limited company or agency was also accountable for handling any applicable tax and National Insurance.
In 2017, the rules changed for the public sector. The responsibility for correctly implementing IR35 shifted from the contractor to the public sector body hiring them. However, in the private sector, the responsibility remained with the contractor.
The April 2021 IR35 changes aimed to bring more consistency between the public and private sectors. The responsibility for determining IR35 status and handling relevant tax shifted from contractors to the private sector businesses hiring them, similar to the public sector. It also made these engaging businesses accountable if HMRC found a status was incorrectly assessed.
These recent IR35 changes in the private sector don't apply to small businesses, though. Contractors working for small business clients continue to determine their own IR35 status.
As per the Companies Act 2006, a small business is defined as having two or more of the following features:
- Turnover of £10.2m or less
- A balance sheet total of £5.1m or less
- 50 employees or fewer.
Who is liable for IR35?
Since April 2021, it's now the responsibility of end clients to determine the IR35 status of their contractors, whether in the public or private sectors. They also need to ensure the correct income tax and National Insurance Contributions (NIC) are paid if the contractor is deemed to be inside IR35.
Contractors are only responsible for determining their own status if they work in the private sector for a client classified as a small business.
Clients communicate their decision through a document called the Status Determination Statement. If a contractor is inside IR35 and directly contracted, the client becomes their deemed employer. This means the client takes on responsibilities like income tax deductions, employee NIC deductions, payment of employer NIC, and the Apprenticeship Levy.
If a contractor is working outside IR35 and HMRC questions this, it may lead to an IR35 inquiry. HMRC can investigate your arrangements at any time, potentially causing time-consuming, costly, and stressful situations. This may involve a review of tax returns from the previous year, and it could extend up to six years if careless or negligent behavior is suspected.
If HMRC finds the evidence unsatisfactory, it conducts a detailed examination of written contracts and working practices, making a final decision on the contract's status. Penalties can apply to both parties if HMRC ultimately determines that the contractor is inside IR35.
Does IR35 apply to limited companies?
As a contractor working through your own limited company, IR35 might impact you. To navigate this, it's crucial to understand how the rules function and follow best practices. This involves ensuring that:
- Your work is project-based.
- You aren't managed by anyone on the client's side.
- You haven't committed to exclusivity with any clients.
- Your contracts are linked to completing specific services, not an ongoing relationship.
If your contract falls inside IR35, you can still work through a limited company, but your client will need to deduct income tax and NIC for that contract.
Contractors outside IR35 may enjoy significantly higher take-home pay. They can benefit from reduced NIC by taking the majority of their income in dividends (currently, you can earn up to £1,000 in dividends before paying income tax on them. Inside IR35, your income is taxed similarly to a regular employee. There are IR35 calculator tools available to assess how the legislation affects your net income.
Can IR35 impact an umbrella company or sole trader?
IR35 typically doesn't come into play when you're working through an umbrella company. This type of company employs contractors and acts as a go-between for the contractor and the client.
When you're paid through the PAYE system and have a contract of employment with the umbrella company, you usually don't need to worry about IR35.
Sole traders are also not subject to IR35, but there are rules to determine their employment status. If a contractor is registered as self-employed but is found to be working like an employee, the end client becomes responsible for paying any additional tax owed.
While the contractor isn't liable for their employment status, there might be a deduction in earnings as they need to be added to the company's payroll.
IR35 Checklist
Here's a checklist to help you gauge if you're inside or outside IR35. Remember, it's a good idea to seek detailed advice on your IR35 status, which may involve reviewing both your service contracts and how you work day-to-day.
Inside IR35
Here are factors that might place you inside IR35:
You personally handle all the work your company is contracted to do.
While working for your limited company, you receive employment benefits like paid leave or sick pay.
Your payment is based on time.
Someone in your client's business closely supervises your work.
Your client provides the equipment, and you work at their premises.
Long-term work is primarily for one client.
Any rejected work is fixed at your client's expense.
You lack your own business identity.
Outside IR35
Here are common traits for those considered outside IR35:
You can delegate or have someone else do the contracted work, and this right is put into practice.
While working for your limited company, you don't receive employment benefits like paid leave or sick pay.
Payment is based on a project or fixed price.
You have the right to decide when and how you work, and you can send someone else to do the job if needed.
You provide the necessary equipment and may work from your own place.
You work with multiple clients simultaneously or on short, consecutive projects with different clients.
If there's rejected work, you're responsible for correcting it at your own cost.
You have your own premises, insurance, and branding.
Frequently Asked Questions
Will IR35 be scrapped in 2024?
No, the IR35 regulations for the self-employed will not be scrapped in 2024. Previously, ex-chancellor Kwasi Kwarteng had tried to reverse the IR35 rule changes from 2017 and 2021. However, the current chancellor, Jeremy Hunt, later chose not to go ahead with this decision. Consequently, the IR35 system continues as it is.
Can I dispute an IR35 decision?
Certainly, contractors have the right to formally dispute the IR35 status assigned by a client. You can express your disagreement up until the point of receiving your final payment. The client is required to respond within 45 days.
Disclaimer: The information provided in this blog post is for general informational purposes only. It is not intended as professional advice, and each individual case may vary. Consultation with a qualified professional is recommended for a thorough assessment of your specific circumstances. Reliance on the content of this blog post alone is not sufficient for making decisions regarding your particular situation.
If you would like to speak to an accountant regarding any tax enquiries, contact info@kmaccountancy.co.uk or 0141 266 0563.
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