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What is the financial impact of IR35 on IT contractors?

There is a considerable difference in the tax and national insurance liabilities of a contractor caught by IR35, and another who falls outside the IR35 net.

In a nutshell, IR35 (the Intermediaries Legislation) was created in 2000 to clamp down on ‘disguised employment’, to prevent contractors and others who would typically be viewed as ’employed’ by HMRC from being taxed as if they were ‘self-employed’.

Outside IR35

A professional contractor who works via his own limited company and whose contracts fall outside IR35 would typically pay himself a small salary (often attracting no PAYE tax or National Insurance liabilities), and derive the most of his income from company dividends.

Inside IR35

On the other hand, a contractor whose contracts fall within IR35 will draw down income in the form of a ‘deemed payment‘. He will have to pay income tax and national insurance contributions on the entire amount.

In addition, people caught by IR35 are granted a 5% expense allowance to cover the costs of running a limited company. They can also claim for standard ‘Section 198’ expenses such as pension contributions and business insurance costs.

Unfortunately, this allowance is not available if you work for a public sector body (from April 2017 onwards), or a private sector organisation (from April 2020 onwards).

All limited company contractors should calculate their Corporation Tax and VAT liabilities in the normal way, regardless of whether they are caught by IR35 or not.

What is the financial impact in real terms?

There is a large difference in the take-home pay of contractors inside and outside IR35.

According to the IR35 calculator on our partner site, ITContracting, if you are a contractor earning £400 per day, you will be around £7,500 worse off if your contract work is caught by IR35.

If you’re on £750 per day, the difference is over £9,500.

These calculations contain various assumptions (e.g. you work for 44 weeks each year).

The vast majority of this tax gap is accounted for by the taxation of dividends. Dividends do not attract National Insurance Contributions, whereas salaries do. The gap has closed by several thousand pounds per year since the introduction of a new dividend tax regime in April 2016, but the difference remains a signification one.

For obvious reasons, you should always seek professional advice before signing a contract, and ensure that both their contracts and their working practices both demonstrate that they fall outside the IR35 net.

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Last updated: 2nd August 2019