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Start-Up Guide :: What is IR35?

Published on Jan 22, 2009 |

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The term IR35 refers to the 'intermediaries legislation' of 2000, which was drawn up to counter the alleged tax avoidance by people working via personal services companies to perform work in a manner more akin to that of a PAYE 'employee'.

This guide provides a high level overview of IR35. You can find more detailed information elsewhere in our IR35 section.

The more commonly used name for the controversial legislation comes from an Inland Revenue (now HMRC) press release from 1999 entitled 'IR35: Countering Avoidance in the Provision of Personal Services'.

What are the aims of IR35?

The prime aim of IR35, which became law via Schedule 12 of the Finance Act 2000, was to ensure that people working via limited companies would be subject to the same levels of tax as 'normal employees', when the limited company worker was performing the same work, in the same manner as the employee.

The tax rules were invented to prevent people who would ordinarily be viewed as 'employed' by the Inland Revenue from being taxed as if they were 'self employed'.

An IT worker might leave his permanent job one day, only to return the following week as a contractor working via a limited company - doing exactly the same work as he did before. In this instance, the contractor would be paying less tax and national insurance as a proportion of his income than he did beforehand. This is the type of scenario the Inland Revenue aimed to target via the IR35 legislation.

What if you're caught by IR35?

A typical limited company contractor who falls outside the IR35 rules would typically withdraw a modest salary (net of employers and employees' national insurance contributions, and income tax), with the bulk of income being in the form of dividends.

If your contract falls within the IR35 net, your income from that contract will be significantly reduced.

Most of your income from the contract will be in the form of a deemed payment, together with a 5% "allowance" to cover the typical costs of running a limited company.

How to be IR35 compliant

In order to escape IR35, both the nature of your contract, and also your working practices, should clearly show that you are 'self employed' as per HMRC's employment status rules.

When entering into a new IT contract, contractors need to ensure that the terms of the contract as well as the way they actually carry out their duties show that they are compliant with the IR35 rules - in other words, that they are not seen to be 'employees' of their client.

The IR35 rules are applied to individual contracts - not to the person performing them. In one year, a contractor may well have 2 or 3 contracts. One may be caught by the IR35 rules, and the others might not.

In the event that your IR35 status is challenged, HMRC will look at a number of factors to determine whether or not your contract falls within the IR35 rules - some being more important than others.

Decisions made in previous IR35 cases may also play a part in determining whether or not a contract should be caught by the rules.

The most important thing you can do is to have your contracts reviewed by IR35 experts before entering a contract.

You may also want to consider taking out IR35 insurance cover - just in case.