An introduction to IR35
IR35 is a tax legislation introduced by the government in 2000 and affects freelancers and contractors who are contracting through their personal limited companies, known as personal service companies (PSC).
Since April 2000, contractors have to determine whether or not each of their contracts could be perceived by HMRC as “disguised employment”. This is where HMRC believes that contractors have set up artificial limited company structures in order to avoid tax, instead of working as a normal employee.
Where a company provides the services of a member of staff to a client (either via an agency or directly) and the terms are such that without the limited company, the individual would be an employee of that client, then IR35 comes into effect.
Trading through a Limited company can lead to significant tax and national insurance savings but if HMRC investigate a contract and decide that it is caught by IR35 they will seek the lost tax and NI. This is because if you are caught by IR35 you can’t pay yourself dividends – essentially everything has to be treated as taxable salary and if you have paid dividends when you shouldn’t have then an adjustment will need to be made.
There are number of key areas that must be considered in order to determine IR35 status, however the three most important tests are; Personal Service & right to provide a substitute, Control and Mutuality of Obligation.
The objective is to prove that a contract is outside IR35 and, therefore, you are able to decide whether to draw a small salary and large dividends from the profit of your limited company, which is the preferred option of most limited company directors, or to take it all as salary. Dividends are more flexible than salary and do not attract national insurance deductions.
Under the legislation, the onus is on the director of the limited company to decide whether a contract ‘passes’ or ‘fails’ IR35, unless the new Public Sector rules apply.
IR35 in Public and Private Sector
IR35 in the private sector:
- The contractor decides own IR35 status
- If ‘not caught’ by IR35 – can pay themselves via low salary and dividends and claim Travel & Subsistence
- If ‘caught’ by IR35 – must do deemed salary calculation, can claim a 5% notional allowance for expenses, but cannot claim T&S
IR35 in the public sector:
The broad categories of the public sector are:
- Government departments, legislative bodies, armed forces
- Local government, NHS, Police
- Schools and further and higher education institutions
- Other public bodies; e.g. British Museum, BBC, Channel4, etc
- Publically owned companies (wholly or partly owned by the Crown and/or the wider public).
UPDATE Jan 2017 – please be aware of the new IR35 rules for the Public Sector which came in from April 2017- if you work in the Public Sector then your client will tell you if you are caught by IR35 or not, and if you are caught they will deduct tax and NI at source. You will have no choice in the matter.
How do I handle IR35?
IR35 is now a significant concern to most freelance contractors. While contracts and working practices can be reviewed, there is no way to determine for certain whether or not a contract is subject to IR35 unless a dispute between a taxpayer and HMRC reaches the courts. The best way to defend an IR35 position is to avoid it becoming a dispute in the first place by taking the necessary preventative measures- we can advise you on this.
In order to avoid IR35 you need to be able to prove that you are genuinely self-employed and working in business on your own account. This sounds straight forward, but, in fact, the distinction between employed and self-employed for contractors under IR35 is grey.
To avoid IR35 successfully you need a specialist contractor accountant to guide you through the maze. The things you’ll need to think about include the all-important control, substitution and mutuality of obligation tests. Also how your contract is structured for IR35 and the working practices under your contract – this is why we strongly recommend that you speak to us for more information and advice regarding IR35.
In its response to the House of Lords Report, HMRC announced that the cost of removing IR35 would be £550million in lost taxes to the Exchequer. As HMRC has created four specialist offices to deal with IR35 investigations, one would imagine that the intention is to police IR35 better in order to increase tax revenues.
However, it is not just enquiry activity that is of concern; the tens of thousands of freelancers in the public sector have to provide an independent assessment of their IR35 status. Moreover, any contractors caught by IR35 will no longer be able to claim Travel & Subsistence Relief on their home to client site travel, which will add a further tax burden.
It is therefore essential to understand your IR35 status; and there is no better starting point than a comprehensive and independent contract review. In partnership with Abbey Tax, we provide a review service to examine your contracts, along with your working practices, to determine whether or not you are operating outside of IR35.
You will receive a written report with suggested contract amendments where appropriate, together with an opinion on your status. Whilst HMRC are still at liberty to challenge the opinion, it does demonstrate that you have undertaken the appropriate level of due diligence. This means that in the event of HMRC being successful in arguing that IR35 applies, they should not be able to levy a penalty, which would save you a further 15% to 30% on any tax bill.