IR35 is a tax law announced in 1999, which took effect from April 2000 as part of the Finance Act. Formally known as the Intermediaries Legislation, IR35 was introduced to stop people who were effectively permanent employees working through an intermediary (a limited company or personal service company) in order to pay less tax.
Although the legislation has a legitimate role to play in defending both workers’ rights from unscrupulous employers and the Public Purse from lost tax revenue, critics of IR35 have claimed that the legislation is confusing and poorly implemented by HMRC.
When working under the legislation, contractors are expected to pay the same taxes as employees, but without any of the safety, security or statutory benefits that employment brings. In April 2017, IR35 rules changed for public sector contractors, making the client or agency, rather than the contractor or freelancer, responsible for deciding whether a contract was ‘inside’ or ‘outside’ IR35.
The reforms led to some public sector organisations announcing a blanket decision not to hire contractors and freelancers working through limited companies. Many public sector contractors responded by leaving the public sector altogether, placing organisations such as the NHS at risk. Despite widespread criticism, the government announced that the legislation would be rolled out to the private sector in April 2020.
Most genuine contractors will exercise a high level of control over their work practice. Typically, they need minimal supervision and won’t be expected to conform to standard working hours at a designated place of work.
A contractor has the right to send such a substitute in their place and also to engage subcontractors to carry out parts of the contract if necessary. In contrast, a contract that requires the work to be carried out by a specific individual points to disguised employee status.
Under normal terms of employment there’s a mutual obligation for the employer to provide continuous work and for the employee to accept it. This obligation doesn’t apply to contractors, who typically work fixed term contracts with a start and finish date. Contractors who regularly work for the same client on new or ‘rolling’ contracts could be classified as employees under IR35.
Keeping organised and comprehensive records relating to your assignments will help contractors to file detailed and accurate self-assessment tax returns. In the event that HMRC decides to raise an inquiry, these records could provide invaluable evidence.
Open communication is increasingly important between all parties who are negotiating the contract to ensure that all are in agreement regarding the contractor’s employment status.
When in doubt, contractors should seek professional advice and consider a contract review service for each assignment.
A contractor should always take the time to read over their contract before signing it. Wherever possible, contracts should include a right of substitution clause stating the contractor’s right to send a substitute in their place or to engage a subcontractor.
Where an agency or client uses a generic contract, contractors can use a confirmation of arrangements letter, which asks the client representative to confirm the most important points about their contract and working arrangements.
When determining employment status, HMRC examines the day-to-day activities of the contractor. In order to differentiate themselves, contractors should avoid typical employee behaviour, such as always eating in the staff canteen or accepting benefits such as sick pay or holiday pay from the client.
When IR35 has been found to apply to a contract, then you (or the fee payer) need to calculate what’s known as the deemed payment on your limited company income. This means that you deduct your Pay As You Earn (PAYE) salary, plus any pension contributions. The remaining amount is treated in the same way as salary paid by an employer, so you must calculate the additional tax due. The most straightforward solution is to pay out all of your limited company’s fees minus legitimate expenses and pension contributions as a PAYE salary. Since you are paying yourself like an employee, then IR35 won’t apply. However, this is only possible if the client or agency allow you to continue working through your limited company on contracts that are inside IR35.
Pension contributions: Contractors working under IR35 in both the private and public sector are able to continue claiming tax relief on pension contributions made by the limited company on the contractor’s behalf.
Expenses: Although the 5% expenses allowance does not apply inside IR35, contractors can still claim the same deductions against their earnings that they would be entitled to if they were normal employees working for that company.
You may find however, that you have multiple contracts in the same accounting period but have a different IR35 status for each contract. In such circumstances the rules only apply to expenses which relate to the engagement which is ‘inside IR35’.
Pulse Accounting has been working with contractors since 2009 and is fully aware of the IR35 legislation and its consequences. We will be monitoring HMRC announcements regarding the implementation of the IR35 changes in the private sector and working with our clients to ensure that they are prepared and informed.
In the event of an enquiry the contractor will be asked to provide copies of their contracts along with their accounts for a specified period, as well as evidence of their IR35 status. Our accountants can quickly supply you with the relevant paperwork that can potentially bring an inquiry to a speedy conclusion.
We can also advise you on specialist outsourced solutions such as IR35 insurance, which will provide you with added protection. We will only refer you to reputable providers who meet our professional standards and we also negotiate a discounted rate for our clients.