IR35 – Are You Affected?
If you are a contractor who provides a service to end clients through your own limited company then this guide is relevant to you. That’s because you will need to make sure that in the running of your company and dealing with clients you don’t act in any manner which might appear similar to having an employer / employee relationship.
Why do you have to avoid giving the appearance of being an employee? Because if HMRC thinks you are more akin to an ‘employee’ rather than an independent business they will adjust (and likely increase) your tax. And if they do so, it will be under something known as ‘intermediaries legislation’, also known as IR35.
IR35 strikes fear into the heart of most contractors because the definition of ‘employee’ seems to widen every year and become ever more complicated, making it easier and easier to be caught unawares.
Hopefully this guide will help you to understand IR35 a little better and provide a little advice as to what you can do to avoid getting caught out.
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As mentioned above, the term ‘IR35’ refers to something called ‘intermediaries legislation’ which is the legislation that HMRC uses to decide if someone is operating as a business or if they are actually operating more like an employee. Why is this relevant?
For HMRC it is relevant because they want to ensure that they are getting the full amount of tax from you. IR35 legislation was first introduced back in 2000 as a way of combating employees who would disguise themselves as personal services companies (companies which sell the work of an individual and which are also owned by that same individual.) They did this in order to access the tax benefits of contractors, which were seen as superior benefits to those available to regular employees. At its most obvious this could mean an individual working for a company, resigning on Friday, setting up a personal service company and then going back to work for their old company the following Monday on better terms. HMRC naturally did not like this!
The same thing applies today. When working through your own limited company you are allowed to split both income tax and NIC’s much more favourably so that you take a lower salary and pay yourself higher dividends. This, of course means greater take home pay than a regular employee.
If HMRC decides to apply IR35 to your contract then not only will they make you pay the same NIC’s and income tax as if you had been an employee, they also may well apply penalties too.The financial cost can be significant on both your future and former earnings.
Contractor or Employee?
In a nutshell then, the intermediaries legislation is there to make sure that the relationship between you and your client would not be seen as one of employer and employee, were the intermediary (an entity sitting between worker and end client such as a limited company or agency) not in place.
This might seem an easy call to make, deciding whether you are a contractor or an employee. Unfortunately, that’s not the case. Most contractors think “I have a limited company, more than one client and the work I do is not permanent – I must be safe!’ Instead, there are a number of hoops to jump through before you can feel truly safe. There is no single defining factor in ascertaining IR35 status, just a number of ‘rules of thumb’ to avoid going on payroll. HMRC are becoming ever stricter in their approach so it is worth sticking to these few core principles (discussed in the next section) to keep you on the right side of the IR35 line.
Determining Your IR35 Status
IR35 status is always determined at the individual contract level and it is often worth taking advice if you are unsure. But there are three well-known guiding principles that should keep you out of IR35 – Control, Substitution and Mutuality of Obligation:
‘Control’ refers to the amount of control your client has over where, when and how you do your job. As a contractor you would expect your contract to include detail on the service to be provided, where it might be provided and the number of hours in which it will be provided. But if the end client decides they need to monitor your service, appraise your service or offer any guidance then this is a more controlling relationship and you are likely to be deemed an employee.
‘Substitution’ refers to an ability to send someone else to provide the service. If you are required to fulfil your contract personally this would normally be another sign that you are an employee. A contractor would have the ability to reassign the work and send a substitute on behalf of their company.
Mutuality of Obligation
‘Mutuality of Obligation’ refers to a dynamic wherein the client is obliged to offer you work and you are obliged to take that work. If this dynamic exists then you would be seen as being part of an employer/employee relationship. A contractor on the other hand has the freedom to work on a job to job basis with no obligation to do more work for a client once a contract is over. They also have the right to terminate contracts part way into the job.
As well as these three guiding principles there are some other things to consider. Contractors should always use their own equipment (unless not safe or practical to do so) and not the client’s equipment. They should also avoid getting involved too much in the company structure or routines – covering everything from using their gym to getting a parking space to their own security pass in the building. Contractors always get paid at the end of the job whilst employees will be paid at regular intervals and contractors are also able to have more than one client at a time.
IR35 in the Public Sector
One of the latest changes to IR35 legislation came in April 2017 when HMRC decided that the onus on determining IR35 status will depend on whether you are operating in the public or private sector.
If you are in the private sector the onus is on you, the contractor, but if you work in the public sector the onus now lies with the agency or end client that is paying your limited company. And if your contract is seen as being inside IR35 then that end client will take care of the NIC’s and income tax (for both you and them) and pay them direct to HMRC!