The UK has always provided certain tax benefits to those working as independent contractors. However, for many years, the problem of disguised employees burdened the UK tax system and allowed individuals to play both sides of the fence. These employees work for a larger company, accept a full time wage and have all of the same responsibilities and demands of any other employee. However, because they have formed a Limited company in their own name, they were able to accept the greater tax advantages that come with being a contractor. This is where IR35 came into play.
In April of 2000, as part of the Chancellor of the Exchequer’s budget legislation, IR35 came into effect. The new law was designed to put an end to contractors benefiting from disguised employment without taking on the additional responsibilities and risks that come with small business ownership.
This legislation has been met with a certain amount of resistance since its passing, both from those who believe no such law should be in effect and from those who claim the law doesn’t go far enough. Regardless of how just the legislation is or isn’t, it isn’t going anywhere in the foreseeable future. Whether you’re a company employee thinking about redefining your role and opening a Limited company, an independent contractor with uncertainty about their tax status or a company owner who wants to stay on the right side of the law, it pays to know as much about IR35 as possible.
IR35 and Its Effect on You
Those individuals classified as independent contractors by their employer whose employment contracts are nearly identical to a permanent employee of the company may find themselves afoul of IR35. In other words, if your contract carries with it the same responsibilities, liabilities, risks and demands of a typical employment contract, chances are you will be defined as inside the IR35 law. As a result, you will be liable for full taxation and full National Insurance regulation. This is due to the fact that the government views your status as being without the risks that come with independent self-employment. Therefore, HM Revenue and Customs has determined that you are not entitled to the corporate tax structure provided to those independent contractors who are taking on those financial risks.
Working Within IR35
Operating inside the confines of the IR35 legislation is not always something to be avoided. In fact, some workers may find it works to their advantage. Here are some of the benefits to operating under a Limited company, rather than working as a full-time employee:
- Increased take home pay – by working within a Limited company structure, you can take advantage of the Flat Rate VAT Scheme, which can add hundreds, if not thousands of pounds of income to your salary.
- Reduced taxation – employees operating under IR35 are only taxed on 95% of their income.
- If you work under an umbrella company structure, 100% of your income will be eligible for taxation.
- Additional benefits include home expenses, reduced company fees and childcare vouchers.
Red Flags for IR35 Consideration
It should be made clear that only an accounting specialist or a representative from the UK government can tell you whether or not your contract falls inside or outside of the IR35 legislation. If you have questions about your employment status, take your concerns to a qualified professional and leave your doubts behind. That said, there are some clear considerations the HRMC will look at when determining your status. Here’s a look at some of these.
Financial Risk – The government provides tax breaks and incentives to those who own their own companies because the financial risk is much greater. Therefore, this is one of the biggest considerations looked at when determining a worker’s proper status. If you are claiming Limited company status but engage in no financial risk, it could be a sign that you are one of the disguised employees the HRMC is keen to stop.
Control – Independent contractors are free to take some jobs, refuse others, raise their rates as they deem fit and so forth. It’s your company and you may run it as you wish. If you do not have these kinds of freedoms (above and beyond asking for a raise), your independent status may be questionable.
Equipment Use – This is a tricky one, but government officials tend to favour independent contractors who use their own equipment for the purposes of their work. If you are a true independent contractor who uses client equipment to perform work, however, this alone is not going to disqualify you for tax purposes.
Right of Dismissal – This is another weak indicator of IR35 status. This kind of contract clause is more often seen in employee/employer situations and not as often in client/contractor relationships.
No Substitution Clause – This is one of the most questioned and controversial aspects of IR35 determination, but it is nonetheless a big red flag to officials. If you are a contractor, it behooves you to include a substitution clause in your contracts, stating that you have the right to bring in a substitute should you be unable or unwilling to perform the duties outlined in the contract. It may even be to your benefit to name said substitutes if you have that option.
Company Benefits – If you are receiving typical employee benefits such as pension contributions, holiday wages, or even if you are regularly attending company functions such as the annual summer picnic, it could be a strong sign that you are a regular employee and not a true independent contractor. This is, again, just a sample of what the HRMC looks at when determining your status under the IR35 laws. In a real audit, they will look carefully at all aspects of your job, your independent company, the company you are performing work for and the level of risk and responsibility you have as a private company owner. In many cases, the biggest red flag occurs when a supposed independent contractor’s employment, reward, job duties and financial risk closely match that of a regular employee’s. When these similarities are too great to be ignored, the HRMC may find you inside IR35 regulations and ensure that you are taxed accordingly.
We hope that you found this article helpful in your quest to understand IR35 and here you will find more information on VAT filings at HMRC!