What Is IR35?

The act that was introduced in April 2000 affects limited company contractors, it is a piece of legislation that applies to limited company contractors, if you are working for a client through your own limited company and you work the same way as an employee of the client, IR35 says you need to be paying income tax and national insurance. Many limited company contractors work outside IR35, meaning they are working on their own account, providing services to a client on a contractor services. These individuals tend to enjoy a greater tax efficiency and pay a mix of salary and bonuses.

​IR35 tends to affect all contractors who do not fulfil the HMRC’s explanation of self-employment. The legislation is designed to tackle the employees who avoid paying their tax. If a worker is caught by HMRC (HM Revenue and Customs), then they will take ‘enforcement action’ to get the money if you do not pay your tax bill. There are many ways they can do to take the tax off you, for example; take things you own and sell them, take you to court, make you bankrupt or close your business etc. When looking into the financial factor of IR35, it is huge. It is stated that the worker’s net income can be reduced by up to 25%, costing the normal limited company contractor lots of pounds furthermore income tax and NICs.

If You Fall Under The IR35 Criteria & What Happens

​It is important to find out if you are ‘employed’ or ‘self-employed’ under the HMRC’s terms.

There will be an overall view of a contractor’s position to conclude whether they fall into the ‘employed’ category regarding the rules, therefore any changed contracts should be reflected on contractors working practices.

There is significant amount of information given about IR35 and how you can keep yourself IR35-free, but if you are selected for an investigation what should you do?

There is an initial HMRC letter and response which will contain them informing you about a check they will be doing in your company. It is vital that the response for this letter is written carefully and provide accurate evidence to prove you’re not caught by IR35. Following on from that, there will be back and forth arguments from both parties, which is the lengthy part of the IR35 enquiry. HMRC may or may not accept the evidence and will take a deeper review on the evidence given. Lastly, there will be a conclusion and HMRC after taking everything into account will make a final decision. If they decide that the case is outside IR35, then the case will be closed from there and the contractor would be allowed to go free, however if they say you are in IR35, they will demand for the retrospective PAYE tax and National Insurance, in addition to that interest and a potential penalty. Here, the contractor still has a right to appeal against the decision, however taking this route is likely to be very expensive.

IR35 Explained

IR35 is the United Kingdom tax legislation designed to tax “disguised employment” at a rate similar to employment. In this context, “disguised employees” means workers who receive payments from a client via an intermediary and whose relationship with their client is such that had they been paid directly they would be employees of the client.

Before IR35 was introduced workers who owned their own companies were allowed to receive payments from clients direct to the company and to use the company revenue as would any small company. Company profits could be distributed as dividends, which are not subject to National Insurance payments. Workers could also save tax by splitting ownership of the company with family members in order to place income in lower tax bands. (This latter practice was recommended by government publications advising on setting up family businesses, but attacked as tax fraud by other government departments, notably the Treasury. It came under separate, ultimately unsuccessful attack in 2007, see S660A.)

On 20 May 2010 the new Liberal Democrat/Conservative coalition Government’s Programme for Government announced a commitment to “review IR 35, as part of a wholesale review of all small business taxation, and seek to replace it with simpler measures that prevent tax avoidance but do not place undue administrative burdens or uncertainty on the self-employed, or restrict labour market flexibility.” On 10 Mar 2011 the Office of Tax Simplification recommended that the treasury should suspend IR35 or compel HM Revenue & Customs to make changes to its implementation until wider structural reform to integrate Income Tax and NIC is introduced. After that, the Chancellor announced the Government would keep IR35 ‘as is’ during Budget 2011, but with changes to HMRC administration and to create a new IR35 Forum.

Background & Contents

In 1999, as part of that year’s Budget, the UK’s Chancellor of the Exchequer, Gordon Brown, announced that measures would be introduced to counter tax avoidance by the use of so-called personal service companies. Properly known as the “intermediaries legislation”, it is more commonly referred to by the consecutively numbered Inland Revenue (now HMRC) budget press release number 35 in which it was announced (i.e. the 35th press release of that year), titled IR35: Countering Avoidance in the Provision of Personal Services. The press release was issued on 9 March 1999, the same day as the Chancellor of the Exchequer’s budget statement.

It came into force throughout the UK in April 2000. Although it was part of that year’s Finance Act and was not law at the start of the Financial Year, the Act backdated its commencement to April 6, 2000. The legislation has been consolidated in the Income Tax (Earnings and Pensions) Act 2003 and in the Statutory Instrument Social Security Contributions (Intermediaries) Regulations 2000, SI 2000/727.

Historically, it had been advantageous for the owners of a small company to take all of their wages in one month, thereby only incurring NI contributions once (up to the monthly ceiling) instead of paying a regular contribution every month like most employees. This ploy had been circumvented some years prior to the introduction of IR35 by imposing NI on the total annual income of directors as if it were spread over the year, even if only paid by one payment. The increased usage of dividend payments instead of wages was partly a reaction to this change. An additional sense of grievance felt by those who were driven to incorporate, for whatever reason, was the large disparity between the National Insurance burden on companies and employees (>20% if the employer’s contribution is included) and that imposed on the self-employed.

​The stated aim of the measure was to prevent workers from setting up limited companies via which they would work effectively as employees, but saving on tax. The so-called “Friday to Monday” scenario, that it was possible for a worker to leave a job on Friday and return on Monday to be doing the same work for the same company, but, as a contractor via their own limited company paying a lot less tax, was cited in the press release as the anomaly being corrected. In such a scenario, HM Revenue and Customs would be allowed to “look through” the contractual arrangement between the worker’s company and the client company and to formulate a “hypothetical contract” which showed that the worker was a “disguised employee”. The fee paid to the worker’s company would then be taxed as a salary. Normal employment status rules should be applied when considering IR35 status and the view of HM Revenue and Customs can be successfully challenged. 

Support

The main arguments adduced in favour of IR35 are:

• There are clearly cases of “Friday to Monday” — leaving on Friday as an employee and returning on Monday to the same job as a hired consultant — which are obviously tax dodges.

• That it is unfair that two workers performing the same tasks should be taxed differently, when there is no real difference between their circumstances.

• That the lower taxation applied to large companies should not be available to small companies, which are in reality one person as income earner (and perhaps a wife/husband handling the paperwork).

Criticism

IR35 has been strongly criticised by several bodies, including the Professional Contractors Group a professional association supporting freelancers, contractors and consultants, by former Ernst & Young tax partner Anne Redston, and by other accountancy bodies, employment agencies, and taxation experts. Some of the key criticisms levelled at the measure include:

• IR35 does not achieve its stated aim of taxing those within IR35 at the same level as employees since those within IR35 also pay Employers NI in addition to Employees NI. This results in much higher levels of tax being paid by those within IR35.

• Its complexity and its harmful impact on many small companies which exist for reasons other than tax avoidance or evasion. These include many companies owned by IT professionals, who often have many short-term contracts rather than one steady employment.

• That its effects extend far beyond the Friday to Monday scenario envisaged in the original press release, which indeed has never been discussed much since.

• That it is unclear whether IR35 applies to an individual contract or not, and the Revenue will not give an opinion until the contract has been signed. As their ruling can imply significant extra taxation, this means that payment negotiations have to be made in ignorance of the taxation costs involved.

• That it is unjust that workers in small family businesses should be taxed as if they were employed by their clients, yet not receive any of the legal, state and other benefits received by “normal” employees.

• There is little evidence that it raises any significant amount of money.

• It renders small businesses uncompetitive with large consultancies and encourages off-shoring.

• The calculation of a “deemed payment” under the legislation is very complex, if you consider yourself caught. The calculation involves 11 separate stages, some of which are recursively dependent on others.

• The introduction of IR35 combined with its complexity and ambiguity, led many freelancers into a number of Tax Planning schemes that led to a further loss of revenue to HMRC.

Information provided by: en.wikipedia.org/wiki/IR35