In this article, we look at IR35 and how it affects contractors. Why umbrella companies are the logical choice for contractors caught by the IR35 rules.
What is IR35?
The Intermediaries Legislation came into force in April 2000, via schedule 12 of the Finance Act. It is known as IR35 after the name of the Inland Revenue (now HMRC) press release which first mentioned the proposed new rules.
Its main aim is to target individuals who work via their own limited companies, while still performing the same work under the same conditions as normal employees. In other words, if you are working in exactly the same way as a traditional employee, not a truly ‘self employed’ person, then the rules may apply to your assignment.
To comply with IR35, you need to ensure that both the wording of your contracts as well as the way you work demonstrate that you are genuinely ‘in business on your own account’, not merely a ‘disguised employee’ (a term used by HMRC).
Contractors caught by IR35 lose the tax benefits of working via limited companies, and it is for that reason that many contractors opt to work through umbrella companies instead.
Umbrella Companies and IR35
If you work through an umbrella company, your will be taxed as an employee. You will pay income tax and National Insurance Contributions on your income.
If your contract work is caught by IR35, and you work via your own limited company, then all of your income will be taxed as ’employment’ income.
After a 5% deduction from turnover on relevant engagements to meet the costs of running a company (in some cases), you will be paid a deemed salary, which is subject to the same tax rules as umbrella company employees.
There are still some benefits to working via a limited company if your are caught by IR35 (such as possible savings offered by the Flat Rate VAT Scheme), but they are vastly reduced.
This is why IR35-caught workers often prefer to use an umbrella company, as there is minimal paperwork involved.
Umbrella companies are therefore not magical ‘IR35 solutions’, and they are only ‘IR35 compliant’ in the sense that they tax their employees in the standard way. Some umbrella companies, particularly in the past, have used IR35 in their marketing material to somehow imply that they can offer something extra.
In reality, all umbrella companies have to tax their employees in exactly the same way, and can only compete on the fees they charge to their clients.
Much has been written about IR35 over the past decade. Here are some good sources for further reading:
IR35 Guides – our dedicated IR35 section.
Umbrella companies – a select list of providers we work with.