IR35 – how does it affect contractors?

what are ir35 rules

The Intermediaries Legislation, otherwise known as ‘IR35’ after the press release which heralded its birth, became law via the Finance Act 2000.

IR35 basics

The IR35 rules were created to target tax avoidance by workers (principally IT professionals) who were leaving permanent jobs and returning as contractors via their own ‘personal service companies’, but still working in the same fashion as traditional employees, rather than as self employed business people.

If you work via your own limited company, and are not caught by IR35, you will pay less tax than you would as a permanent employee. Most of your income will be extracted as dividends, which do not incur National Insurance Contributions (unlike salaries). In addition, you may be able to split your shareholding with a non-working partner and spouse, using their own tax-free allowance. There are a number of other tax benefits in addition to these main ones.

HMRC believed that if someone was merely a ‘disguised employee’ working via a limited company purely for tax purposes, then they should be forced to pay full income tax and National Insurance on their income.

As a result of the implementation of IR35 in 2000, it is clearly in the best interests of all contractors to ensure that they can demonstrate that they are ‘self employed’ rather than ’employed’, as there is a significant gap in take home pay between those caught by, and those free from IR35.

Are you inside or outside IR35?

In order to demonstrate that your assignment is not caught by IR35, in the event of an HMRC status enquiry, you need to be able to demonstrate that both the terms of their contract, and your working practices show that you are ‘in business on your own account’, and are not merely a disguised employee.

Some of the main factors used by employment status experts in determining IR35 status include whether or not the individual is under the direct control of the client, whether the contractor has the right to provide a substitute if they are unable to work, and if there is the expectation of ongoing work when the current project comes to an end.

Unfortunately, even if the contractor – agency contract is drafted to show that the contractor is very much ‘self employed, and this contract matches the agency – client contract in its intentions and wording, HMRC will also look at how the contractor carries out his duties in practice. It is therefore important that you can demonstrate that you are operating a genuine business – for example by having a business website and email address, taking our professional business insurance, being VAT registered, having company stationery, and not appearing to be ‘part and parcel’ of your client’s organisation, like a permanent staff member would.

Accounting for IR35

IR35-caught contractors must pay themselves a deemed salary (subject to full income tax and NIC deductions), rather than dividends, which will result in a significantly higher tax bill, although the legislation does allow IR35-caught companies to claim a flat 5% allowance of turnover to cover administration expenses, as well as ‘Section 336 expenses’ (travel, subsistence costs, etc.).

Unsurprisingly, when you are choosing a new accountant, we suggest you only consider contractor specialists who are well-versed in all things related to IR35.

The term ‘IR35 Accountant’ doesn’t actually mean anything – it is more a marketing phrase using a keyword which is clearly of great interest to the contracting industry.

All specialist contractor accountants should have a thorough knowledge of the Intermediaries Legislation – both in terms of complying with IR35 (ensuring that your contract work doesn’t fall within its scope), but also in dealing with any potential HMRC enquiries, and accounting for IR35 if any of your work is deemed to fall within scope.

Measures to take to ensure you are IR35 free

Firstly, you should always submit your contractors to an IR35 contract review service. They will be able to determine what risk your contract would have to being caught by IR35, and what measures you can take to improve your compliance with IR35. Some review services will even negotiate contract wording changes with your recruitment agency on your behalf.

You may also consider purchasing a tax investigation insurance policy which will cover all costs of professional representation if you are ever selected for an HMRC status review. The annual cost for IR35 insurance is not expensive – from around £100 per year, although you can pay significantly more if you want to cover the possible tax liabilities you might have to pay if you are deemed to be caught by IR35.

One of the leading suppliers of both contract reviews and IR35 insurance is Qdos Contractor, who we have worked with for many years. You can access their website here.

Read more in our IR35 protection article.