What is IR35?
A tax law, IR35 was introduced to tackle tax avoidance in those who work as contractors compared to those who are full-time employees of a company. When you work full-time as an employee your tax is controlled and calculated by your employer. However, when you are a director of a limited company you are in control of your tax and how profits are extracted from the company.
This often means that those who are directors of a limited company pay less tax than those who are full-time employed but who earn the exact same money.
For example, an employee earning £120,000 pays about £5,000 more tax as an employee compared to a typical company director.
Why it was introduced
The HMRC, rather unsurprisingly see this as being a way to avoid paying tax (by the employee) and a way to avoid having to make NI contributions and offer employee benefits (by the employer) and wanted to ensure that using this system as a method to get around paying as much tax was stopped.
In effect, if you have set up a limited company purely for the purposes of saving tax then you might come unstuck.
The public sector now has seen a huge clampdown, so much so that hospitals won’t use public service companies and you have to be employed. This may well come into the private sector at some point too.
What is inside and outside IR35?
One thing that can cause confusion when it comes to IR35 is the terms that are used to describe those who it affects. If you, as a contractor are seen to be inside IR35 then this means that you could be in breach of its rules and HMRC will set about investigating you as a business. This is not a quick process and can take some time to complete, as well as cause you a whole lot of stress along the way. You may even find that at the end of the investigation, you are asked to pay back all of the tax that you would have paid had you been a legitimate employee of the business, rather than working for them as a contractor or freelancer. HMRC can go back several years too!
How do you work out your IR35 status?
It is down to you to work out your IR35 status, which is one of the biggest causes of headache in the entire process. HMRC will often use what they call a hypothetical contract, which is where they will look at the contract that runs between the worker and the client at the end of the process. It will take into account the working practices and the contractual terms between the limited company and their client.
For example, if the client (or who they may deem to employ you) has control over when you take holiday as well as the hours that you work, well then they are treating you as an employee and you will be seen as being inside of IR35.
It can be hard to know where to turn with IR35 however, you shouldn’t feel that you can’t ask for help. At RJF we can help you determine the most tax-efficient structure for you and your company to ensure you don’t fall foul of IR35 or any other legislation.