IR35 Issues and Guidance
IR35 is something that’s been on the agenda for more than a decade now and if you’re contracting you shoul dbe aware of it. However, when we speak to people it’s often the case that they don’t have a good grasp of it. And to be fair, it is a complex issue.
So what is IR35?
IR35 penalises anyone who uses a self-employment vehicle, like a limited company, to disguise what is really an employment relationship between them and their customer.
If you’re an employee under a different name, then you should be receiving your earnings from the customer as wages, and paying income tax and NI contributions to HMRC.
If HMRC decide you fall foul of IR35, you’ll have to pay all this tax and NI back to them – which could be a substantial penalty going back several years.
Tell me more…
IR35 came into force in 2000, to deal with an emerging trend of people leaving their company’s employment and returning as ‘contractors’, when in reality, nothing in the working relationship had changed.
In the years leading up to the introduction of IR35, we were in recession: redundancies were on the rise and employers were under pressure to keep headcount down. And the tax legislation in force at the time indirectly encouraged companies to engage staff off-payroll.
The system was clearly being abused, and the Finance Act 2000 was HMRC’s response. The provisions regulating the engagement of contractors became known as IR35.
Is it easy to interpret?
Not really. You need an expert tax accountant to advise you. It’s not black-and-white, and it’s still relatively early days, so there isn’t much in the way of case-law to help interpret it.
The legislation is written in a vague and imprecise way. What’s relevant to working out your position is not just your contract with the customer (and any extensions, renewals or revisions), but also the circumstances surrounding the working relationship.
IR35 is not intended to stop genuinely self-employed people working for themselves or through a limited company.
The key thing is for you to be comfortable you are one of the genuine ones, so you can carry on running your business with peace of mind, knowing HMRC won’t come after you at some future date for back payments of tax and NI contributions.
We can advise you. Find out how.
How does the penalty calculation work?
You get taxed on your ‘deemed salary’ for the tax year.
If what you’ve actually received from your limited company as salary and benefits over the year is 95% or less of what the customer has actually paid under the contract, the balance is taxed as deemed salary. Generally, you’ll have retained this amount in the company or paid it to yourself as dividend, so HMRC will have received less tax and NI contributions than it should have done.
The danger is when you get assessed for the extra tax, you may already have spent the earnings!
So how do I avoid the penalty?
The only way to avoid the penalty is to do all you reasonably can to operate as a genuinely independent contractor.
If HMRC were ever to investigate your business, they would apply a number of tests to decide if you’re covered by IR35.
- The amount of control you have over how you work: are you in charge of your hours, where you work, how you get the job done? The more control you have, the less likely you’ll be deemed to be an employee.
- Whether you can provide a substitute to work in your place: if the contract is with you and you alone, then that points to a contract for personal service (i.e. employment), rather than a contract to get a particular job done. Obviously the client values you, that’s why they’ve hired you, but at least consider including in your contract a power for you to send someone else along in your place – if you’re ill, for instance.
- Do you have any other clients? Most businesses have more than one customer. Employees tend to work for just one employer.
- Is there mutuality of obligation between you and the client? When the job’s done, the contract shouldn’t set up any future obligations – you should be able to accept new work or turn it away.
- How much financial risk are you taking? Employees rarely take on personal financial risk, but if you’re in business on your own, you have all sorts of risk to worry about, from paying rent and rates on your premises to servicing loans and managing cash-flow.
- What benefits do you receive? If you’re eligible to receive the benefits employed staff enjoy, it makes you look like you’re part of the workforce. As an independent contractor, you shouldn’t sign up to the company pension scheme or receive share options, holiday or sick pay.
- Do you provide your own equipment, like computer and phone? If you do, you look more like an independent contractor than an employee.
- How are you paid? Employees tend to be paid monthly, or at other regular intervals. As a contractor you should be paid by the job. Your role is task-based: you get paid to deliver. Think about how you negotiate payment with your client.
What are Managed Service Companies?
They are companies set up to avoid IR35. HMRC was finding it challenging to keep them in check and enforce penalties against them, and the IR35 legislation was at risk of losing its teeth.
Under new powers, HMRC can now recover tax, interest and penalties from a wide range of people involved in the MSC – including the directors and intermediaries who helped set it up.
Should I set up an MSC?
No. My FD is not an MSC, and setting up MSCs is something we absolutely do not condone and will not do.
At My FD, we act with integrity to save you money, the honest way.