IR35 is the tax legislation designed to stop individuals, whose working arrangement reflects employment, from paying less in tax when providing their services to clients through their own limited company.
Due to its complexities, and the fact that many factors need to be considered when deciding whether a contractor should be classed as a self-employed individual or an employee for tax purposes, IR35 is controversial and widely unpopular.
What is the purpose of IR35?
To stop tax avoidance among contractors. The government thinks independent workers are paying themselves more tax efficiently and through their own limited companies when, in actual fact, many of these contracts should be classed as employment, meaning these workers should be taxed like employees.
How is IR35 changing?
Up until April 2020, contractors working in the private sector will still be able to decide whether they fall inside or outside IR35. From this date on, however, the responsibility for setting IR35 status will be passed over to the client, with whichever party acts as the fee-payer set to carry the liability – typically this will be the client or, when involved, the recruitment agency.
The incoming reform will apply to medium and large companies in the private sector. The rules have applied to public sector organisations since 2017.
Contractors are worried that clients are inexperienced with regards to IR35 and will look to protect their liability by making inside IR35 decisions, meaning these individuals will be taxed like an employee without receiving any of the benefits that come with employment.
Thousands of contractors working in the public sector were wrongly placed inside IR35 by inexperienced clients upon the arrival of changes in 2017, meaning they were taxed significantly higher. To an extent, this is still happening.
For private sector companies to be able to continue attracting self-employed contractors, it’s important they prepare for reform and ensure they are in a position to make accurate IR35 decisions.
This would allow genuinely self-employed contractors to continue operating outside IR35 where they can pay themselves marginally more tax efficiently.
When does IR35 take effect?
IR35 has been around for nearly 20 years, with the government introducing it in 2000. However, from April 2020, contractors will not have the power to decide their IR35 status in the private sector, unless they contract for a client who falls under HMRC’s definition of small (companies who meet any two of the following criteria: a turnover of £10.2 million or less; fewer than 50 employees; £5.1 million or less on its balance sheet).
Does IR35 apply to self-employed workers?
IR35 doesn’t apply to sole traders - only contractors working through their own limited companies, which are often referred to as personal service companies.
When operating outside IR35, a contractor is responsible for their own taxes and is able to pay themselves in the most tax efficient way – usually made up of a combination of salary and dividends.
If a contractor works inside IR35, they are deemed employed for tax purposes, meaning they are subject to PAYE just like an employee. Up until April 2020, contractors in the private sector must calculate a deemed payment of income tax that they owe HMRC for operating under IR35.
From April 2020 onwards, however, contractors inside IR35 will be taxed at source. The fee-payer in the supply chain (either the client or recruiter) will subtract the tax before paying the worker. This means contractors won’t be required to work out the ?deemed payment?. This has been the case in the public sector since 2017.
I’m a contractor. How can I ensure I don’t fall inside the IR35?
First and foremost, the contract between an individual and a client must reflect a contract of service (outside IR35) and not a contract for service (inside IR35). The individual needs to approach the working engagement as if it is a business providing a service for another business – and the terms and conditions of the contract need to demonstrate this.
Other factors, such as being able to provide a substitute, not being obliged to carry out work, along with anything else that points towards the engagement not being representative of employment should be included in the contract.
While the contract itself is vital, so are the actual working practices, given they tend to reflect the reality of a working relationship. In other words, a contractor must be able to exercise any clause or demonstrate anything that points towards outside IR35.
Can I claim expenses incurred as a contractor if I am inside IR35?
Currently, if a contractor works inside IR35 in the private sector with a particular client, they can claim a 5% expenses allowance. This rule takes into account potential administrative costs a contractor incurs when calculating the deemed payment, which in simple terms is the amount of tax they’re required to pay when operating inside IR35.
Because the responsibility for doing this will soon be passed to the client, the 5% expenses allowance will be scrapped – as it has been in the public sector.
Where can I get further advice?
From us of course! Feel free to contact us if we can help with any queries around this.
Individuals often have their contracts reviewed by an independent IR35 expert, who will be able to advise them on where they stand. With IR35 reform on the horizon and the threat that private sector companies could well make mistakes, the need for contractors to have confidence in their IR35 status before a client sets it is crucially important.
Contractors should have their IR35 status assessed – preferably by an expert. They can also find further guidance on the GOV.UK website.