If you are considering becoming a contractor or own a business that hires contractors or you are currently working as a contractor, IR35 is tax legislation that you should be familiar with.
There are many advantages of working as a contractor and one of the best advantages are the tax benefits self-employed contractors are liable for working through a limited company. However, IR35 rules are in place and all contractors must adhere to stay fully compliant. IR35 was first introduced to crack down on tax avoidance and to ensure contractors working in the same way as full-time or part-time employees pay the same national insurance and tax.
IR35 is a UK tax legislation introduced in April 2000 designed to help identify businesses and contractors fraudulently claiming tax benefits by avoiding paying the appropriate tax and working as a ‘disguised employee’.
IR35 and working as a contractor
Working as a contractor through a limited company means you can pay corporation tax at 20% on your profits, avoid National Insurance Contributions by paying yourself through business dividends and claiming business costs against your tax bill. Many chose to work as contractors because of these benefits as it is often more tax-efficient than working as a full-time or part-time employee or working through an umbrella company.
Many contractors who are operating the same way as an employee whether intentionally or unintentionally are gaining a tax advantage over others working the same way as them. The Government announced IR35 as a way to stop this unfair advantage and at the same time, increase its overall tax revenue.
With the recent reform of IR35 in the private sector, it is up to the contractor to determine their IR35 status although this is due to change in 2021. In the public sector, it is the client's responsibility to determine the IR35 status.
The IR35 changes were expected to be fully implemented on 6 April 2020, however, because of the coronavirus (COVID-19) pandemic in the UK and globally, the government announced the delay in IR35 which meant the new regulations were deferred to 6 April 2021.
What are the IR35 changes?
The government plans to align both the private and public sector regarding the IR35 rules.
IR35 was first introduced in 2000 and it was the sole responsibility of the contractor to assess their IR35 status and it was the individual's limited company agency to determine the National Insurance and tax due where IR35 applied. In 2017 changes were made to the public sector so that the responsibility of assessing the IR35 status shifted from the contractor to the public body engaging them, whilst the responsibility in the private sector remained with the contractor.
The planned changes in the private sector are due to take place in April 2021. The responsibility for determining the IR35 status will be passed onto the private sector businesses engaging the contractor, which means the private sector business will be held liable should HMRC investigate the engagement and determine the IR35 status to be incorrect.
It's worth noting that the IR35 changes in the private sector exclude ‘small businesses’ which means contractors working for them can still determine their IR35 status.
Contractors liable for IR35
What are the new IR35 rules? Until March 2021, it is up to the end client in the public sector to determine the contractor's IR35 status and, if the contractor is operating inside of IR35, the end client will have to ensure the correct NIC and tax is paid.
Contractors working in the private sector are still able to determine their status until April 2021, when the end client with the private sector will determine the IR35 status of the contractor.
HMRC can investigate a contractor if there is reason to believe their IR35 status is incorrect. They will begin with an open IR35 enquiry asking for evidence that they are working ‘outside’ of the legislation and if HMRC decides that the evidence is not satisfactory, they will conduct a more in-depth investigation of the contractor's written contracts and working practices. An IR35 investigation can become costly, time-consuming, and stressful as they can go back up to six years and evaluate past contracts.
If they decide that the contractor falls ‘inside’ an IR35 status, then the contractor will be liable for the retrospective tax, NIC, plus a potential penalty and interest accrued.
Operating inside IR35 means that you fall under the IR35 legislation and you’re liable to pay the same tax and National Insurance as an employee. This also means you’re entitled to the same rights as an employee or worker such as maternity pay, minimum wage and many other benefits.
Operating ‘outside’ IR35 means that the legislation does not prevent you from paying tax as described above on a private contract basis, meaning you can pay yourself a salary and withdraw additional income as dividends all whilst your limited company pays tax on profits at a corporate rate of 20%.
Many things can help indicate you are outside of IR35 and operating as a business, these include having your business insurance, owning your equipment, working for multiple clients and marketing yourself with a professional website.
IR35 and limited companies
IR35 applies to contractors working through their own limited company. Working through an umbrella company means you don't have to worry about IR35 as you’re already paid through the PAYE system. IR35 does not apply to sole traders but the rules for determining employment status do.
If a contractor who is registered as self-employed is found to be working as an employee, then the end client will be responsible for paying the additional tax due and the contractor may experience a loss of earnings as they will have to be placed on the payroll.
If you're working through a limited company as a contractor, then it is vitally important that you understand the legislation and apply the best practice, meaning you need to meet HMRC’s definition of self-employment by ensuring your work is project-based, you’re not managed by anyone on the client-side and that you haven't offered exclusivity to any of your clients.
IR35 compliance checklist
Listed below are some of the points to consider when determining your IR35 status. Please note this list is non-exhaustive and if you’re unsure, you must seek professional guidance.
- You are paid on a time basis
- You are supervised by somebody in your clients business
- You work for one long-term client
- You do not have your own business identity
- You work via your limited company, but receive all employment benefits
- You work via your limited company and receive no employment benefits
- You are paid on a project basis or fixed rate
- You work with more than one client and at one time
- You have your business premises, branding and identity
- You have the right to provide a substitute to work should it be required
The new IR35 rules
In the 2018 budget the chancellor announced that the public sector IR35 rules would be extended to the private sector in April 2020, however, due to the severity of the COVID-19 pandemic, these IR35 changes were then deferred to April 2021. The new rules are as follows:
If your client is a small company, your limited company is then responsible for assessing the IR35 status and whether this applies. The Companies Act 2006 defines a small business with two or more of the points below:
- 50 employees or fewer
- A balance sheet of £5.1m or less
- Turnover of £10.2m or less
- Private and public sector businesses working with contractors are responsible for assessing the IR35 status of the individual and disclose whether they are inside or outside IR35
- If the end client is a small business as per the description from The Companies Act 2006 then the rules do not apply
- If the worker is determined to be working inside IR35, the agency, business or third party that pays the contractors limited company will need to deduct the appropriate tax and NIC
- If the worker is found to be non-compliant with IR35, the end client will be responsible for paying the income tax and NIC to HMRC
IR35 is complex, however, by fully understanding the legislation and taking the best course of action to comply with the IR35 rules you will still be able to work tax efficiently, whilst staying on the correct side of the law. Whether you’re a contractor or you work with contractors, you must fully research how to be compliant and if unsure seek professional guidance.