The IR35 is a UK tax legislation in place since April 2000. It was designed to prevent self-employed contractors who are effectively employed by their end-clients from avoiding income tax and national insurance contributions.
This article clarifies all you need to know about the IR35:
- What is IR35?
- Why is it called IR35?
- Does IR35 apply to you or your contractors? Are you a “disguised employee?
- What does working “inside or outside IR35” mean?
- What happens if IR35 applies? How much do you need to pay back to HMRC?
- What’s next for IR35?
What is IR35?
IR35 is a UK tax legislation, announced in the Spring Budget of March 1999. It came into force in April 2000. It’s also called the “Intermediaries Legislation”.
It’s now been split and consolidated into two:
- its income tax component is now part of the Income Tax (Earnings and Pensions) Act 2003 also called ITEPA 2003
- its National Insurance element is now part of the Social Security Contributions (Intermediaries) Regulations 2000.
It’s been implemented by HMRC to prevent “personal services companies” from avoiding paying income tax and National Insurance.
This legislation is going after “disguised employees” – workers (often contractors, freelancers, interims or consultants) who set-up limited companies to save on Income Tax and National Insurance, while in effect being permanent employees of companies.
To give you an example in the fiscal year 2018/19:
- If you pay yourself £100,000 of dividend, you have to pay £19,874 in dividend tax (19.9%), no income tax, no employee’s NI, and your company wouldn’t have to pay any employer’s NI. You would take home £80,126.
- If you’re paid the same amount, £100,000, as gross salary, you have to pay £5,627 in employee’s NI, £28,360 in Income Tax and your company would have to pay £12,637 in employer’s NI. You would take home £66,012.
The difference (£14,114) speaks for itself!
Why is it called IR35?
In March 1999, the then-Chancellor of the Exchequer, Gordon Brown, announced in the Spring Budget Statement a number of anti-tax avoidance measures.
At the time, the HMRC was called the Inland Revenue (IR). The so-called “Intermediaries Legislations” was the 35th item of the press release of that budget – hence its name!
Does IR35 applies to you or your contractors? Are you a “disguised employee”?
The HMRC has created an online tool to help you determine whether IR35 applies to you or your contractors.
HMRC uses a number of factors or “employment tests” to determine the status of a worker. Control, right of substitution and mutuality of obligation are seen by industry experts as the most important factors to determine whether IR35 applies or not:
- Control: Does the client control or have a right of control over where, when and how the service is provided? If yes, there might be a contract of employment. If not, typically if the contractor has autonomy in the way they deliver their services, IR35 does not apply.
- Right of substitution: Can the contractor, at its discretion, send a substitute to carry out the services, provided they have the same skills, experience and qualifications? If not, there might be a contract of employment.
- Mutuality of obligation: Does the worker expects to receive a steady stream of contracts or regular work from the company? Is the contractor obliged to accept further contracts? If yes, there might be a contract of employment. The HMRC states: “where work is regularly offered and accepted over a period of time, a continuous contract of employment may be created.”
What does working “inside or outside IR35” mean?
- Working “outside IR35” means that the HMRC considers that you’re genuinely self-employed. As a contractor, you’re allowed to pay yourself a salary and draw dividends, without having to pay national insurance.
- Working “inside IR35” means that the HMRC considers that you’re not a self-employed contractor but an employee of your end client. You are subject to PAYE and should pay income tax and employee’s national insurance. Your end client should pay employer’s national insurance.
What happens if IR35 applies? How much do you need to pay back to HMRC?
If IR35 applies, i.e., if as a contractor, you’re considered as an employee rather than self-employed, HMRC will ask to recover the unpaid income tax and national insurance for a period that can go back at least six years, plus potentially penalty and interest. This can amount to a lot of money!
What’s next for IR35?
IR35 comes with a number of controversies – its rules can be difficult to understand and to apply.
A number of lawsuits have emerged recently, appealing HMRC’s decisions, with mixed level of success. Last year for example, Christa Ackroyd (Christa Ackroyd Media Ltd (TC6334), former BBC presenter, lost her appeal at the First-tier Tribunal. The Tribunal confirmed that she should have been an employee and not a self-employed contractor. Her company was deemed to owe HMRC £419,151 in income tax and National Contributions.
In light of these challenges, the UK government has just launched a consultation on IR35 (or “the reform of off-payroll working rules”) on March 5th 2019, to close on May 28th 2019. The reforms should be implemented from April 2020.
Watch this space! What would you like the reform to do?