IR35 is supposed to deter consultants from trading through a limited company, a personal services company. The reason for this being to prevent the avoidance of tax and national insurance by trading through an “intermediary” rather than being an employee.
IR35 came into effect in 2000 and has been contentious ever since. An entire IR35 industry has sprung up around the legislation.
Prior to IR35, any individual could form a limited company and invoice their “client”/”employer” and then have their own limited company pay them a minimum salary and take the remainder of their income as dividends. This avoided national insurance and tax through PAYE on the dividend element.
Who is affected by IR35?
Although, traditionally IR35 affected IT contractors and engineers, the legislation is not actually limited to a particular trade, occupation or business sector. All kinds of consultants and contractors can find themselves within IR35.
If you personally perform services for your customer or client, through an intermediary, you may fall into IR35 if you could be deemed an employee of your customer if it were not for the existence of the intermediary, which is normally a company but could be a limited liability partnership (LLP)
Are you inside or outside IR35?
HMRC publishes an employment status checker which it will stand by, provided that you have answered the all the questions accurately which will indicate whether IR35 (off-payroll working) applies to you.
You will need to examine whether IR35 applies on a “contract by contract” basis. It is possible to have some contracts within IR35 and some outside IR35
The circumstances of your “intermediary” is also a factor. For example, if the intermediary is a limited company – who owns the shares and in what proportion?
The wording of your contract and your working practices are also factors. Although there is no such thing as an “IR35-proof” contract. In the event of an enquiry, HMRC would examine the reality of your situation, not just your written contract.
(“Inside IR35” – IR35 legislation applies to your circumstances
“Outside IR35” – IR35 legislation does not apply to your circumstances)
The Financial Consequences of Being Inside IR35
The financial consequences of being inside IR35 are mainly (there are other consequences) you lose the tax-avoidance facility of dividends.
Essentially, if you are within IR35, you must calculate a “deemed payment” and pay NICs and PAYE (tax) on that deemed payment.
The tax-deductible amounts that you can claim in travel and expenses will also be affected.
Basic Financial Comparison of being Inside and Outside IR35
Suppose, during 2020/21, you are paid £50,000 by your client. Ignoring expenses:
As a contractor outside IR35, you would traditionally pay £9,516 (which is the national insurance primary threshold) in salary and take £32,792 as dividends (after paying corporation tax)
You would pay no tax on the salary, no national insurance.
You would pay £2,086 personal tax on the dividend.
Your company would have paid £7,692 corporation tax on the profit.
Total payable to HMRC: £9,778
Now suppose you are paid £50,000 by your public sector client and are inside IR35. You would have a deemed payment of £44,983. There would be £6,495 in personal tax and £4,362 in national insurance. You would also have to pay £5,017 in employer’s national insurance contributions.
Total payable to HMRC: £15,874
*In practice, there are some allowable expenses that would be tax deductible before having to arrive at the deemed payment. These are called section 198 expenses and these include business travel, professional indemnity insurance and qualifying pension contributions.
If you are within IR35 but in the private sector, you are also allowed to deduct 5% from your income. This 5% allowance is not applicable if the client is in the public sector.
Off Payroll Working in the Public Sector
In April 2017, changes in legislation mean that public sector organisations now have responsibility for deciding if IR35 applies to a contractor and if it does, the organisation must deduct tax and national insurance and pay it to HMRC.
As a result, most public sector organisations now take contractors onto their payroll or say that the contractor must use an umbrella company (which would apply PAYE and national insurance)
From April 2021, a Status Determination Statement (SDS) must be provided to the contractor.
Off Payroll Working in Medium and Large Companies in the Private Sector
From April 2021 (the date was postponed from April 2020 due to the coronavirus crisis) medium and large companies (and some other businesses & organisations to whom the simplified test applies to) will have the same responsibility (as the public sector) to determine the employment status of a worker.
And if it is determined that the off-payroll worker rules apply, then tax and national insurance must be deducted and paid to HMRC.
Additionally, the 5% allowance will also not be available from April 2021.
A Status Determination Statement (SDS) must also be provided to the contractor.
Off Payroll Working in Small Companies
The responsibility for determining employment status rests with the contractor if their clients is a small company. The contractor may ask their client if they qualify as “small” and the client must answer.
Lack of Employment Rights
Unfortunately, as it stands at the moment, contractors within IR35 and subject to the deemed payment arrangements do not have the same employment rights. As the contractor is not an employee of the fee paying client, they do not count in the employee numbers and the client does not have to pay holiday pay, auto-enrolment pension contributions, statutory payments or make student loan deductions.
Essentially, “employment” for tax purposes (as IR35/off-payroll-working aims to address) is different from the contractor having employment rights with the fee-paying client.