Whether you’re new to contracting/consulting or you’ve been around for a while, you could not have escaped hearing about IR35. IR35 is a fundamental issue which you will need to consider at the very start of your contracting/consulting career and every time you accept a contract.
The IR35 rules seek to determine the circumstances under which a contractor/consultant should be treated as ‘self employed’ or ‘employed’ for tax purposes. If deemed ‘outside’ of IR35, a contractor/consultant is viewed as self employed and can be subject to business levels of tax. If ‘inside’ IR35, they should pay employee levels of tax which can be considerably higher.
What is IR35?
IR35 is a term that is used to denote UK tax legislation that is designed to tax “disguised employment” at a rate similar to employment. IR35 was announced in the March 1999 Budget and came into effect from 6 April 2000.
Prior to the introduction of the legislation, an individual could avoid being taxed as an employee on payments for services and paying Class 1 NIC by providing those services through an intermediary. The worker could take the money out of the intermediary, normally a Personal Service Company, in the form of dividends instead of salary. As dividends are not liable to NICs, the use of a dividend remuneration strategy results in the worker paying less in NICs than either a conventional employee or a self-employed person. And PAYE would not apply to the dividends.
What is the financial impact of IR35?
The financial impact on contractors/consultants caught by IR35 is significant, resulting in the payment of more tax.
A Limited Company contractor/consultant who falls outside the IR35 rules would typically withdraw a modest salary (net of employers + employee’s NI, and income tax), with the bulk of income being derived from dividends.
For a contractor/consultant caught by IR35, all his/her yearly income to the end of the tax year will be treated as a salary (or “deemed payment”). Income Tax and National Insurance will be due on the entire amount – paid throughout the year.
Corporation Tax and VAT are calculated in the normal way, regardless of IR35.
The difference in the take-home pay between a contractor/consultant inside IR35 and another outside is significant. For this reason, contractors/consultant should always seek professional advice before signing a contract, and ensuring that their contracts satisfy the Inland Revenue’s definition of “self employed” work as per the IR35 employment status rules.
There are several ways of not being included in the IR35 legislation:
The ideal position is to show that you are self-employed as per the Inland Revenue definition of the term. This will require an IR35 friendly contract, with working practices which match those stated in the contract.
Below are some recommended guidelines for what you should include in your contract:
- The contract is to be made out to the Limited Company not to an individual
- The contract is signed by the Director or authorised representative of the company
- There is an end date and / or information explaining the termination clauses
- The contract has a substitution clause. This allows the company to send any approved consultant representing it to do the work – it does not have to be the director / person who signs the contract. (This is very important with regards to IR35.)
- The Limited Company is solely responsible for paying all of the correct taxes
- There are clauses relating to liability and the responsibility for the company to provide the necessary insurances
- There are clauses relating to the possibility of the company having to provide its own equipment
If you are unsure on whether your contract falls inside or outside of IR35 you should be able to ask. At YP Finance we are keen to ensure its contractors/consultants obtain good professional advice in respect of their assignments and IR35.