IR35 is a tax legislation designed to mitigate tax avoidance by workers, particularly contractors, who supply their services through the use of intermediaries.
Introduced in 2000 by HMRC, IR35 is effectively a means of identifying individuals who are providing clients with a service under an intermediary, such as a ‘personal service company’ (usually in the form of a limited company), that would normally be classified as regular workers, known as ‘disguised employees’, without the existence of said intermediary.
Determining whether you’re operating inside or outside the scope of IR35 is mind-bogglingly complex and requires a thorough understanding of your unique situations. For the purposes of this article, our team of London’s local accountants for contractors aims to explain the various requirements for contractors under IR35, as well as gives an outline of the best practices for ensuring that you aren’t categorised as a ‘disguised employee’ under IR35’s classifications. Information given in this post should not replace professional advice tailored to your specific circumstances.
Why was IR35 introduced?
Previously, companies who engaged these disguised employees saved a significant amount of money as they didn’t have to pay employers’ National Insurance Contributions, nor provide any employment benefits.
On the other hand, contractors operating through a personal service company could also minimise their tax obligation as they were more inclined to split the income between salary and dividends. Dividends aren’t subject to National Insurance Contributions and also taxed at a lower rate, resulting in contractors paying less taxes and getting a higher take-home pay than a normal employee would.
It was a win-win scenario for companies who engaged contractors and also for contractors themselves. However, because HMRC did lose out on tax revenue they would otherwise receive, they had to close the loophole by introducing IR35.
In short, IR35 legislation was effected as a mechanism for cutting down on individuals wrongfully claiming tax advantages as contractors (or through other intermediary means) when they would normally otherwise be classified as regular employees.
In April 2000, IR35 became effective for small businesses supplying clients with contractor services and aimed to better establish the conditions by which contractor-client relationships exist for tax purposes. Despite their best efforts, the Government has been widely criticised for IR35, particularly with respect to its implementation and the impacts it can have for legitimate contractors and their small companies.
Am I at risk of coming under IR35?
Anyone who works as a contractor is potentially at risk of being categorised as a ‘disguised employee’ under IR35, and if you are deemed to fall inside this definition by HMRC, you will face some severe tax implications.
The problem with IR35 is that there is no definitive guideline that stipulates the conditions of a ‘breach’ so to speak, and as the issue is contractual in its nature, anyone investigating on behalf of HMRC is required to make a notional judgment based on the relationship between the company and the contractor rather than on the ‘written’ agreement.
As such, it is often difficult to determine whether you’re categorised as a ‘disguised employee’ in certain circumstances. Typically, HMRC looks at the working arrangement and uses these three principles (aka tests of employment) to determine the employment status of an individual.
Principle 1: Control
This refers to how much control the company has over you the contractor, from what you do, how you do it, when you start and finish it to where you complete it. If the client requires you to come in from 9 am to 5 pm every weekday for a specific period of time to finish a series of tasks, then HMRC is likely to classify you as a normal employee and therefore IR35 is applicable.
Principle 2: Substitution
A normal employee cannot go out to source for an individual to complete their work for them but if you are a genuine contractor, you should be able to send a substitute to undertake the work on your behalf, provided that your client is reasonably satisfied that the proposed substitute has the right skillset and qualifications to undertake and complete the work.
Principle 3: Mutuality of obligation
This concept hinges on the question: is there a degree of obligation with respect to the employer supplying the work and the worker accepting this offer? If you are a genuine contractor, you must have the right to terminate the contract early if you choose to.
Understanding these principles can offer an insight into circumstances where a contractor may come under IR35 categorisation, however, these are not exhaustive and there are other factors that can be taken into account when making a judgment. For example, HMRC may check if you receive any employment benefits or if you use their equipment to complete your work to name but a few.
We’re specialist contractor accountants
Essentially, it’s important for a contractor to consult a specialist contractor accountant like Tax Agility to better ascertain where they sit with respect to this legislation and whether they may be required to pay more tax as a result. While there are a number of IR35 calculators that might be able to give a rough estimate, it’s always advisable to go to a professional. Call us on 020 8108 0090 today or send us a message via our Contact Form. We offer the first consultation for free in order to understand your circumstances and provide you with the best possible advice with regards to your contractor work.
For more information, check out our contractor pages:
- What are the pros and cons of contracting?
- What does the IR35 legislation mean?
- Tax advice for contractors
- Important dates and deadlines for contractors
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