If you are new to contracting, it is inevitable that you will hear the term ‘IR35’. But what is IR35 and how does it affect you as a contractor? IR35 is the name of a piece of tax legislation that was put into place by HM Revenue & Customs (HMRC) in 2000, which is used to combat tax avoidance by those who should be paying taxes as a regular employee but aren’t.
If you work via an intermediary or personal service company (PSC), such as a limited company, IR35 rules will help you determine your tax status, and whether you are genuinely self-employed or a ‘disguised employee’.
HMRC defines this tax status as 'inside' or 'outside' IR35. Put simply, they can be defined as:
1. Inside IR35: you are a ‘disguised employee’ or 'temporarily employed'
2. Outside IR35: you are 'self-employed'
If you are determined to be ‘Inside IR35’ you will need to pay the same NICs and income tax as a regular employee. If you are ‘Outside IR35’, you can pay yourself through your limited company as a self-employed individual would.
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Your IR35 status is indicated by the terms of your contract and by several factors including, but not limited to, control, substitution, and mutuality of obligation. We’ll explain these further:
• Control: what amount of control does your end-client have over how, when and where you complete the work laid out in your contract?
• Substitution: can you, or are you required to, send someone to complete the work in your place?
• Mutuality of obligation: is your end-client obligated to provide you with work and pay you for it, and are you obligated to accept?
These three terms alone can be confusing, and attempting to make sense of your contract terms based on IR35 terminology can be tedious and could lead to you making an incorrect assumption of your IR35 status. If you or your recruitment agency are unsure, it is always recommended to seek the advice of a tax status expert who can review your contracts, help re-draft contracts for IR35, and even provide representation in the event that HMRC investigates you for potential backdated tax owed.
Important Note: if you are a contractor in the public sector from 6 April 2017, you are not able to determine your own IR35 status – it must be determined by the public sector body providing you with the assignment.
• Outside IR35
If you are able to receive payments to your limited company outside IR35, you can decide the level of salary to pay yourself and claim back any legitimate business expenses. If you choose to pay yourself outside IR35, you will be paying income tax and NICs at the self-employed level. Anything left in the business account after this will be profit, on which Corporation Tax must be paid. The remaining profits can then be distributed to the shareholder(s) as a dividend. This way of working returns a significant increase in take home pay over working inside IR35.
• Inside IR35
If you pay yourself inside IR35 you will be paying tax similarly to an employee of your client. If you receive payments to your limited company inside IR35, some basic personal expenses could potentially be claimed, however the rest of the income will be treated as salary, including employers NI. This way of working returns a significant decrease in take home pay over working outside IR35.
If you are unsure about your tax status, request a callback from one of our experts and we can talk you through your options.
Working self-employed through an intermediary or PSC, such as a limited company or limited liability partnership, and taking income through a combination of salary and dividends, allows contractors to pay lower rates of National Insurance and less income tax than regular employees.
However, HMRC deemed that too many individuals were taking advantage of this tax loophole, and avoiding paying the correct amount of tax and NICs. HMRC believed that many of these individuals would be regular employees were it not for their limited company arrangement, and therefore should be paying the correct tax. IR35 was introduced to tackle this perceived avoidance through the use of these intermediaries.
HMRC can start an IR35 enquiry into a contractor's engagements at any time. They will scrutinise the written contract(s), working practices and true facts of the engagement. If it discovers that the contractor is 'caught' by IR35, they will require all backdated tax and NI, plus interest and penalties, to be paid if the contractor were previously paying himself outside the IR35