Many people may find the term "IR35" to be obscure, but it has immense importance for individuals as well as companies working in the contracting world. Aimed at curbing tax evasion by employees who provide services to clients through a limited company or another intermediary, IR35 is a set of tax regulations that were introduced by the UK government in 2000 and is also referred to as "off-payroll working rules."
Contractors, corporations, and even tax experts found the IR35 rules to be a confusing concept for a long time. There are severe penalties for breaking the rules, and they are complicated. Knowing this law well is therefore crucial, especially with regard to what it means to be "Inside IR35."
Inside IR35 Meaning
When a contractor's relationship with their customer and the nature of their work combine to make them "inside IR35," HMRC would treat them as employees for tax reasons. This difference is crucial because it can greatly raise the contractor's and their employment intermediary's (for example, a Personal Service Company, or PSC) tax and National Insurance Contributions (NICs) liability.
However, if a contractor is considered to be legitimately self-employed and falls "outside IR35," their PSC will be able to pay them in a way that is more tax-efficient.
Determining the IR35 Status
The type of working relationship a contractor has with the client determines whether they are classified as "Inside IR35" or "Outside IR35" based on a number of variables. Here are three of its most important points to consider:
- Control: Who makes the decisions on what, where, when, and how to accomplish the work?
- Substitution: Can the employee send someone else to complete the task in their place?
- Mutuality of Obligation (MOO): Is there an obligation for the worker to accept work and for the client to provide it?
Additional Tip: The UK government provides the Check Employment Status for Tax (CEST) tool to help in determining a contractor's status. This tool isn't perfect, though, and it's important to take legal consultation when in doubt.
Implications of Being Inside IR35
The status of inside IR35 affects freelancers and contractors in significant ways. First off, it impacts their tax obligations. Despite not having the same security and benefits as normal workers, some contractors may still have to pay income tax and NICs in the same way. Their net income may drop significantly as a result of this.
Second, their business structure may be affected if they are inside IR35. Normally, they enjoy the advantages of lower responsibility and more tax efficiency. However, many of these benefits would be lost if they were inside IR35, as their limited company would essentially be disregarded for taxation reasons.
Third, contractors outside IR35 enjoy certain tax-deductible business expenses like travel, home office, fees, and equipment, lowering their tax bill. However, those inside IR35 lose this perk.
And lastly, non-compliant contractors may face hefty tax penalties, potential credit score damage, and, in extreme cases, disqualification from company directorships if they are found to be misclassifying themselves.
First of all, businesses need to conduct assessments to determine a contractor's IR35 status. After that, making sure the appropriate tax and NICs are paid is also the responsibility of employers who engage contractors inside IR35.
Moreover, it is the responsibility of the client to complete and submit payroll returns for contractors deemed inside IR35. This applies to both the public and private sectors, with the exception of small businesses in the private sector, where the contractor remains responsible for their own tax affairs.
Lastly, employers may face hefty penalties for misclassifying IR35. This includes a 100% base levy plus 30-100% surcharges for negligence or worse.
Inside IR35: Benefits and Drawbacks
While most independent contractors would want to avoid being considered inside IR35, it isn't always a detrimental thing for them.
Being inside IR35 has benefits like:
They might be eligible for certain employee perks, including sick pay, holiday pay, and pension contributions, depending on the client's employment policies.
Since they are less likely to be fired without cause or notice, they might enjoy more job security and stability.
- Because they are not required to manage a limited corporation or file complicated tax filings, they will have significantly less administrative and accounting load.
But, drawbacks of being inside IR35 include:
- Being subject to PAYE (Pay As You Earn) taxation at the source and being unable to deduct certain costs or expenses may result in higher tax and national insurance contributions for some.
- Since they are bound by the client's regulations and procedures, they can have less freedom and control over their job.
- Because they cannot market themselves or take on new clients and are not viewed as a separate entity from the client, they may have fewer opportunities to expand their business and reputation.
Inside IR35 Expenses
Being inside IR35 has significant ramifications for what costs are allowed to be claimed.
Contractors who are inside IR35 are eligible to receive tax savings on pension contributions made through their personal service company, but they are not eligible to receive the 5% expenditure allowance. Furthermore, general employment expenses and expenses for travel and lodging are not eligible for reimbursement. On the other hand, certain contractors who are inside IR35 can still be qualified for the flat-rate VAT programme.
In summary, think of IR35 misclassification, like forgetting to put on sunscreen at the beach. You might use SPF 50 lotion (like the CEST tool), but even if you miss a spot (a misclassified contractor), the sunburn (a hefty fine) is inevitable. Therefore, it is of utmost importance for both companies and contractors to understand what it means to be inside IR35 and the implications of it. This will ensure IR35 compliance and safeguard your financial interests.
Disclaimer: The information in this article does not constitute legal advice. Please seek legal advice if you need guidance regarding IR35.