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HMRC first implemented the IR35 legislation in 1999 to proactively check employment status for tax purposes. Employed individuals are within IR35, whilst those who are genuinely self-employed are not covered within the rule.
However, this status determination was not taken seriously until 2018, as a response to the IR35 reforms in April 2017, wherein most contractors and employers get to choose which applies to them, and because of the tax and full-time work benefits outside the scheme, many of them enlisted to this status.
This has benefitted both hirers and contractors for years, but now, HMRC inspectors are looking closely into contractors’ statuses so that they pay the taxes they should have been paying considering their real nature of status or contract and collect the accurate inland revenue anticipated every year.
This article aims to provide comprehensive guide about all that hirers and contractors need to know about the IR35 legislation, how declaring the wrong status affects them, what it entails being inside or outside this finance act, how to correctly determine their status, and whether they choose to work through a limited company or an umbrella company.
What Is IR35 Legislation?
IR35, properly known as Intermediaries Legislation in 1999, is also known as off-payroll working rules, another of HMRC’s initiatives to prevent tax evasion in the UK, but this time, particularly in the case of contractors and hirers. Up until 2018 and the press release by Chancellor Jeremy Hunt, the lines between the two—inside or outside the IR35 scheme— were not strictly evaluated, so many had been knowingly or unknowingly violating the legislation.
This has resulted in £1.3 billion amount of tax revenue avoided each year, as at such a time, 90 per cent of workers determined themselves outside this rule. The tax legislation aims to sift the contractors inside IR35 from those genuinely outside IR35 and find those who are deemed as “disguised employees,” giving a complete u turn to those who are exercising non compliance.
To do so, HMRC inspectors will not take into account the hirer and worker’s written contract but proceed to check their actual working relationship nature to make a “notional contract,” which also serves as their status determination statement. They will look at whether the contract is of employment and IR35 applies to the worker or it is a legitimate business to business contract in which IR35 rules do not apply.
Who Does IR35 Apply To?
The IR35 legislation may affect the following:
- Contractors who operate through an intermediary or their personal service company such that they underwent CIS registration as limited companies, and determine their status to be outside the scheme.
- Clients who receive services from their worker who operates through an intermediary or limited company.
- Agencies that provide workers’ services through their intermediary.
In the case of workers, they are considered employed and fall within IR35 status, otherwise deemed as “disguised employees,” when they work and act like employees but are off the payroll, even receiving the benefits that full-time employees have and pay less tax. However, if they were employed directly, they would have been considered employees and are responsible for paying the same taxes as regular employees instead of tax on self-employed income.
IR35 tax rules aim to extract from these companies or contractors the corporation tax they owe, with leniency in the case of corporation tax on losses. If HMRC finds them enjoying the tax advantage of improperly declaring they are outside the IR35 status, where the workers use the full-time worker perks and register as a limited company but are employees in nature, these individuals under “deemed employment” may be suspected of tax avoidance schemes.
They are supposed to be considered employed and inside IR35 in the first place and, thus, will have to pay the tax bill they owe for being one through the PAYE system, discussed further below. HMRC can go back a minimum of six years to evaluate contracts, so any amongst the contractor, hirer, or agency could be paying thousands of pounds as a result.
Effects of the IR35 Crackdown
Workers usually chose to declare being outside the status because of its tax benefits, but now that the IR35 crackdown is in place, they have to be wary about really being one before classifying themselves outside the rule. Genuine freelancers, interims, consultants, contractors, and sole trader pay corporation tax and are excluded from the rule, but they are required to check and ensure whether the rule doesn’t apply to them so they can justify when HMRC makes tax investigations over their status.
Workers outside the scheme are genuinely self-employed, which means they provide their clients with their services as a genuine business, making it a business-to-business contract, in which case the IR35 will not apply. They are deemed by HMRC as non-violators of the rule and will not be facing penalties or additional fees.
Unlike those inside IR35 with a contract of service, they are holding a contract for service as a legitimate business. Because of this, they pay less income tax and National Insurance contributions, which they will be handling by themselves and can withdraw their funds in a way that suits them.
What Happens If You Are Inside IR35?
Those considered inside IR35 are employees in nature, not self-employed. They are expected to pay the same amount of income tax and National Insurance as of regular permanent employee through PAYE, reducing their net income by up to 25 per cent. They will not receive the same employment benefits, though, such as sick leaves or paid holiday leaves.
Income tax and National Insurance contributions (NICs) will be deducted from the gross pay by the hirer before they pay the net amount to the contractor’s limited company. The hirer or client should carefully calculate their workers’ NICs to avoid paying the inaccurate amount, one of the tax avoidance schemes that could subject them to CIS penalties.
Ninety-five per cent of the contractor’s income is considered employment income, and the rest goes to employment taxes. Contractors working inside IR35 can claim limited expenses but not the same expenses as those who work outside the legislation, such as travel and subsistence expenses.
What Happens If You Are Outside IR35?
Workers usually chose to declare being outside the status because of its tax benefits, but now that the IR35 crackdown is in place, they have to be wary about really being one before classifying themselves outside the rule. Genuine freelancers, interims, consultants, contractors, and sole trader pay corporation tax and are excluded from the rule, but they are required to check and ensure whether the rule doesn’t apply to them so they can justify when HMRC makes tax investigations over their status.
Workers outside the scheme are genuinely self-employed, which means they provide their clients with their services as a genuine business, making it a business-to-business contract, in which case the IR35 will not apply. They are deemed by HMRC as non-violators of the rule and will not be facing penalties or additional fees.
Unlike those inside IR35 with a contract of service, they are holding a contract for service as a legitimate business. Because of this, they pay less income tax and National Insurance contributions, which they will be handling by themselves and can withdraw their funds in a way that suits them.
How to Determine Your Status Correctly
Assessing the right status can be a complicated matter as it means large-scale contract reviews for each of the contractors or workers, which is why a lot of clients work with tax experts in this matter, unless they operate small businesses. However, medium and large businesses can use IR35 Shield for Business which can help them assess all their candidate contractors in one day.
The assessment usually just takes at least 15 minutes and gives accurate results. They can also use HMRC’s CEST tool (Check Employment Status for Tax) to determine their employment status for corporation tax, income tax, VAT Notice 708, and National Insurance contributions (NICs) purposes.
The end client is responsible for determining the contractor’s status, but if their business qualifies as a “small” from taxman’s perspective, it is the contractors’ responsibility themselves to determine their IR35 tax status. There are three key points to determining if an individual is outside IR35 status. If they don’t meet the following criteria, then they are immediately inside IR35:
- They have control over the services they offer and how they deliver them, including where and when they work, as well as manage their service delivery. They have full autonomy over their work and, thus, are not controlled by their client.
- With Mutuality of Obligation MoO, they have their own start and finish dates for the project, change the contract if their work evolves, and can even turn down a project. They are not obligated to provide their service and accept any project.
- They have the right of substitution, wherein they can recommend another contractor if they cannot perform the project. The service is not personal, so they can send anyone if they are not able to do the work.
Contractors Inside IR35: To Work Under Limited or Umbrella Company?
Whilst working outside this tax rule can be more tax-efficient, there are benefits to working under a limited company instead of working under an umbrella company, the latter being exempted from the IR35 rule. Operating under a limited company and being inside IR35, contractors receive higher pay through the Flat Rate VAT Schemes, which they would not have had if they worked under an umbrella company.
Those under umbrella companies are automatically outside the legislation simply because they are working under an umbrella company and deem it as their employer. The company itself deals with the necessary deductions and payments of the contractors’ self employed tax liabilities.
They get all the employment benefits and protections, such as holiday pay, maternity or paternity pay, workplace pension, and more, and are still able to maintain the freedom of contracting. Either way, they are legible for CIS mortgages.
How Legend Financial Can Help
Determining the right IR35 status can be really tricky, and the penalties can be severe. On determining the right status of your contractor or if the responsibility of classifying statuses falls on you as a contractor of a “small business,” it is wise to work it out with tax experts and avoid reporting to HMRC with inaccurate information.
Legend Financial is here to help with your IR35 needs, from determining statuses to paying taxes. Our chartered accountants for ecommerce and tax experts have been serving a lot of clients on this matter on a daily basis, so you can trust us to do the job efficiently and expertly. Reach us today!
References
What is IR35? Does it apply to your contract? (n.d.). Retrieved from Contractor Calculator: https://www.contractorcalculator.co.uk/what_is_ir35.aspx
Understanding off-payroll working (IR35). (22 August 2019). Retrieved from Gov.UK: https://www.gov.uk/guidance/understanding-off-payroll-working-ir35#:~:text=The%20rules%20make%20sure%20that,sometimes%20known%20as%20’IR35′.
Being inside or outside IR35: Knowing where you fit in the legislation. (n.d.). Retrieved from Michael Page: https://www.michaelpage.co.uk/advice/management-advice/ir35-guide-contractors-and-employers/being-inside-or-outside-ir35#:~:text=What%20is%20IR35%3F,for%20at%20any%20one%20time
Working Outside IR35. (n.d.). Retrieved from SJD Accountancy: https://caroola.com/resources/compliance-legal/outside-ir35/
Working Inside IR35. (n.d.). Retrieved from SJD Accountancy: https://caroola.com/resources/compliance-legal/inside-ir35/
