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IR35 Rules – How do they impact you?

When you’re working as a contractor, it’s important to ensure that you are fully compliant with all regulations and legislation affecting your preferred method of working, particularly if the consequences impact your tax bill.

 

Also known as intermediaries legislation, IR35 is a set of rules implemented by HMRC that were intended to clearly define what constitutes and differentiates an employee as opposed to a contractor.

 

The purpose of the IR35 legislation is therefore to combat tax avoidance by identifying those who operate as “disguised employees”.

 

A genuinely self employed individual who falls outside IR35 and is working through a limited company can elect to pay himself a low salary on which they pay National Insurance, with the remainder of their income being made up of dividends (which aren’t subject to NI) .

 

However under IR35 legislation an individual who would be classed as an employee but for the fact that he/she uses an intermediary (such as a limited company) cannot  take advantage of benefits from tax measures which are for people who are genuinely self-employed .

 

It will already be clear that IR35 is notoriously complex and the guidance available often raises more questions than it answers. To assist you in understanding IR35 we have produced an easy-to-follow guide to IR35 that provides a background to the IR35 legislation and considers the recent public sector reforms.

 

Below and in the follow up article we have prepared a more in-depth overview of the IR35 rules:

 

  • What is IR35
  • Who does it affect
  • What are the recent changes to IR35 legislation, and
  • What is the potential impact of IR35 rules for 2018?

 

What is IR35?

 

Introduced as law in 2000 via the Finance Act 2000 (Schedule 12), IR35 is an aspect of tax legislation that is, fundamentally, aimed at identifying individuals who are avoiding paying the tax they would pay if they were employed. The legislation was designed to address the issue of employees who disguise themselves as a personal services company in order to reap the benefits that come hand in hand with operating as a contractor rather than an employee.

 

When operating through a limited company, it’s possible to benefit by splitting your income into a salary (which is subject to National Insurance and tax) and dividends (which can be taxed at a lower rate of income tax and are not subject to National Insurance).

 

If a contractor working through a limited company takes a low salary, with their income then boosted by high dividends this reduces the amount of tax and National Insurance that can be collected from an individual and any employer, something the government is keen to avoid.

 

Until April 2017, it was the sole responsibility of the contractor to ensure that they did not fall foul of IR35, however post April, the responsibility for determining whether IR35 applies to a contractor operating in the public sector was changed.

 

HMRC revealed that it will be public sector bodies, not recruitment agencies or contractors themselves who will be responsible for determining whether IR35 applies to a specific public sector contract. This change came into effect on April 6th 2017 with significant consequences for the sector.

 

How do I know if IR35 rules apply to my contract?

 

Today, the below simple test applies to those working in the private sector.

 

Although the test has multiple parts, it can be summarised neatly:

 

“If you act, think, and look like an employee, then you fall within IR35”

 

An easy way to think about this, is by looking at your working habits, for example:

 

  • Does the client you work for require you to wear a uniform?
  • Do you have to request holidays from your client?
  • Do you have agreed working times i.e. set hours from 9 a.m. -5.30p.m.?
  • Can you send anyone else who is qualified to do your job as a substitute if you are unavailable?

 

Of course, without following someone night and day, it’s difficult to prove that they fall foul of IR35, so the contract between the client and their contractor has been the main focus for checks of this nature.

 

Although in reality, certain answers to the above test questions may be “yes”, agencies, clients and contractors have tried to ensure that the contracts they have used did not reflect the above, so as to avoid any obvious IR35 penalty.

 

However once HMRC looks at the “substance” of the relationship the facts overtake the “form” and the relationship is deemed to be caught by IR35.

 

 

How do you get paid if your contract falls under IR35?

 

In the event that the IR35 rules apply to your contracts, there are three alternative ways you can get paid as a contractor:

 

PAYE –. In this instance, you are employed directly by the end client.

 

Umbrella Company – usually for a fee of £15-£25 per week. You are an employee of the umbrella company. Public sector bodies prefer this type of arrangement as it removes any risk of being caught by IR35 and the umbrella company will ensure that the correct taxes are paid.

 

Limited Company – most contractors will pay an accountant to operate their own PAYE and file their accounts. However as you cannot pay dividends or offset expenses against any income from the IR35 contract there are few benefits to using this model. In some circumstances clients have deducted PAYE at source from contractors using a limited company option to ensure there are no IR35 liabilities.

 

Important things to consider if your contract falls under IR35  

 

If you operate via a limited company and you’re affected by IR35, you must process 100% of your daily or weekly pay rate through PAYE (less any admin fee).

 

Because you will now be deducting an admin fee (a standard charge via an umbrella & often charged by your accountant) from your day rate, unless your rate is significantly higher than that which you would receive if you were employed, you will actually end up worse off by being a contractor.

 

What’s more, as a contractor, you will in fact be liable for your employers National Insurance contributions (at 13%), in addition to your own contributions (at 12%). This will further impact upon your net take home pay.

 

 

What are the penalties of IR35?

 

The penalties of falling foul of IR35 are levied on the contractor, not the end client.

 

In the event that you are caught by IR35, you will need to pay the difference between the tax you would have paid if you had been employed during the contract, and the amount you actually paid through your limited company.

 

In addition to this, you will be subject to a fine. This fine varies depending on the circumstances:

 

  • 30% of unpaid tax – if your mistake was accidental
  • 70% of unpaid tax – if you deliberately avoided being caught by IR35

 

Next Steps

 

To understand more about the impact IR35 rules across public and private sectors, please read IR35 Rules for private and public sector contractors here.

 

For further information about IR35 compliance, for a IR35 review and how these changes could affect you, please get in touch for a free, no obligation 10 minute consultation.

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