IR35 has been a thorn in the side of limited companies that provide professional services since 2000. The financial consequences if your work is caught by this tax rule are significant.
Here, we look at what IR35 is, and how to ensure that your company falls outside its scope.
We also look at the ‘Off Payroll’ rules are – separate, but related legislation. And – confusingly – also referred to as ‘IR35’.
Why was IR35 created?
From the late 1980s onwards, the IT industry saw a boom in the number of professionals opting to work via their own limited companies as ‘contractors’, rather than being payrolled employees.
As the numbers increased, HMRC believed that many of these new company directors were in fact ‘disguised employees’, rather than bona fide small business people.
Many would be working 9-5 for an employer one day, only to return the next day – performing exactly the same work – as limited company contractors.
If you work via your own company rather than staying in traditional employment, you will pay less overall tax – mainly due to the fact that National Insurance Contributions (NICs) are not payable on dividends.
The differential is smaller than it was in the late 1990s, thanks to the recent dividend tax hike, but it is still beneficial (tax-wise) to be a contractor than a traditional employee.
In response to the huge growth in numbers of so-called ‘personal services companies’, the Government implemented the Intermediaries Legislation (IR35) with effect from April 6th 2000.
These rules were created to combat what it saw as widespread avoidance of tax and NICs by disguised employees. The legislation is contained within Chapter 8 of ITEPA 2003.
The term ‘IR35’ originates from the number of the press release which first detailed HMRC’s planned clampdown.
What are the IR35 rules exactly?
In essence, if you undertake a contract role, and the terms of the contract and the way you perform the role is more akin to a normal employee than a ‘self-employed’ person, then that particular contract would be subject to IR35.
After allowing for a fixed 5% allowance* to meet the cost of running your company, the remaining contract revenue will be subject to normal taxation (NICs and income tax).
The net return from a contract could be cut by 25% if it is deemed to be caught by IR35.
* does not apply in the public sector
2017, 2021 – the ‘Off Payroll’ rules are introduced
In April 2017 following concern that disguised employment is rife in state-run organisations, a new piece of legislation – ‘Off Payroll’ working – was created. The legislation is contained within Chapter 10 of ITEPA 2003.
According to the HMRC, “this measure moves responsibility for deciding if the off-payroll rules for engagements in the public sector apply, from an individual worker’s PSC to the public sector body, agency or third party paying them.”
The new rules forced clients to decide whether or not workers were subject to IR35 or not. The onus for determining employment status therefore switched away from workers themselves.
The fee-payer in the employment chain is responsible for deducting employment taxes from the worker’s income.
Following a COVID-related delay, the Off Payroll rules were also rolled out across the private sector from April 2021 onwards. This led to a dramatic drop in the number of limited company contractors working for end-clients.
The only exemptions from the new rules are ‘small companies’, where the original IR35 rules still apply (i.e. the worker continues to self-assess their IR35 status).
Many risk-everse clients have opted to blanket ban limited company workers, due to the heavy penalties associated with non-compliance.
Off-Payroll changes to be repealed in April 2023
In dramatic fashion, the new Chancellor Kwasi Kwarteng has announced that the Off-Payroll rules will be abolished in April 2023, which means a return to the pre-2017 ‘old’ IR35 rules.
This means that individuals working via their own companies will be responsible – once again – for determining their own IR35 status. Very welcome news.
How do you know if your work is caught by IR35?
In the event of a tax investigation by HMRC, the terms of your written contract and your working conditions will be examined to provide an overall picture of the true nature of your work.
Some of the main factors considered include:
- Control – to what extent is the contractor under the direct control and supervision of the end-client?
- Substitution – can the contractor provide a substitute if they are unable to perform their contract duties?
- Mutuality of Obligation – when the current fixed-term contract period has expired, is there a reasonable expectation of a renewal?
Even if these factors are concisely addressed in the written contract, they must also reflect the reality of how you work.
Read more about IR35 on ITContracting.com – lots of in-depth guides.
How can I protect myself against IR35?
If you provide professional services to clients via your limited company, you should actively take steps to minimise the chances of your contract work falling within the scope of IR35.
Firstly, you should submit all new contracts to a professional IR35 contract review service provider. If your contract terms and working practices are found to be lacking, they should suggest ways to strengthen them.
They may also work directly with any intermediaries (e.g. recruitment agencies) to implement any improvements.
Secondly, you should consider taking out tax investigation insurance in case you are selected for an HMRC compliance visit.
Depending on the type of policy you take out, your company will be covered for the cost of professional representation during an HMRC investigation.
You may also take out more comprehensive policy which will cover your company for the costs of any taxes you may be deemed to owe following an HMRC investigation.
The leading provider for contract reviews and IR35 insurance is Qdos.