The notorious IR35 legislation takes its name from a 1999 Inland Revenue press release, ‘Countering Avoidance in the Provision of Personal Services’.
Its aim was to ensure that individuals did not leave permanent jobs only to continue working in a similar way, but via limited companies (intermediaries) to save tax.
Contractors working via limited companies are not liable to pay national insurance (NICs) on their income – resulting in a revenue loss to the Treasury.
The IR35 rules became law via the Finance Act 2000 (Schedule 12).
You can read more about how IR35 came into force in our history of IR35 guide.
The fundamentals behind the IR35 rules
IR35 was invented to attempt to clamp down on the widespread use of personal service companies by individuals who would ordinarily be classed as ’employees’ according to their work practices.
Employees pay NICs on their salaries, and employers’ NICs are also payable. If a limited company contractor takes a modest salary and the remainder of his income as dividends, there may be no National Insurance liability at all.
In order to work out if an individual’s contract is subject to IR35 or not, a complex series of employment status rules exist to determine whether or not a person would be ’employed’ or ‘self-employed’ for tax purposes.
You can read more about the implications of your employed status in our guide to IR35 compliance.
For example, a contractor who works on a client site under the direct supervision of his client, using the client’s equipment, and the staff facilities, is likely to be deemed to be ’employed’ under the self-employment rules.
However, a freelancer who works from home can provide a substitute if he is unavailable, and has multiple clients, is far more likely to be deemed as ‘self-employed’ and therefore free from the burdens of IR35.
It is important to note that, when assessing a contractors’ IR35 status, HMRC will consider his working practices as well as the terms of the contract itself. The IR35 rules apply to the contract itself, not the individual.
It may be possible for an individual to work on several contracts during a given period of time, and for just some contracts to fall within the IR35 net.
You can read HMRC’s ’employed or self employed’ leaflet (formerly known as ‘IR35’) for some employment status pointers.
What if you are caught by IR35?
If your contract is caught by IR35, you will draw most of your income in the form of a deemed payment, together with a 5% ‘expense allowance’ to cover things like insurance and pension contributions.
Although you may still be better off contracting via a limited company under IR35 (by using the Flat Rate VAT scheme for example), many contractors caught by the rules join umbrella companies for a hassle-free way to contract.
There is a significant difference in take home pay if you are caught by IR35, so we strongly recommend you use an IR35 contract review service before signing a new contract.
You might consider taking out IR35 insurance just in case you need professional representation following an HMRC status review. This type of cover should not set you back more than £100-£150 per year.
The Coalition – an IR35 overhaul?
When the Coalition Government came into power in 2010, one of their first tasks was to set up the Office of Tax Simplification (OTS) to look at how small businesses are taxed, particularly with reference to IR35.
In its March 2011 interim report, the OTS proposed three ways forward for IR35 – suspension with a view to abolition, the creation of a new set of IR35 tests, or to continue with IR35 ‘as is’, but with better HMRC enforcement.
Given that the Government could lose a significant sum in NIC receipts from umbrella company contractors who would incorporate if IR35 were abolished, the Chancellor elected to keep IR35 “as is” with a promise to ensure that the rules are policed more effectively to remove much of the uncertainty caused by compliance.
Recent IR35 Developments
As part of the IR35 overhaul, an IR35 Forum staffed by various industry experts meets on a regular basis to oversee ‘improvements’ in the way IR35 is administered.
In May 2012, HMRC published new Business Entity Tests (BETs), aimed at showing individuals what risk they face of being selected for an IR35 investigation. The test has been roundly criticised by industry experts as being inaccurate and doing little to provide certainty to contractors.
From April 2013, IR35 has been extended to include ‘office holders’ – typically high ranking consultants who take high-level decisions on behalf of their client companies.
In October 2014, HMRC announced that it would no longer be using its Business Entity Tests from the start of the 2015/16 tax year.
Public Sector IR35 changes – April 2017
From April 2017, new rules tackle so-called ‘off-payroll’ working in the public sector. Clients, not contractors themselves, are now tasked with determining the IR35 status of contractors, and for deducting any tax and NICs deemed to be owed – at source.
HMRC has also created a new IR35 tool to help those affected work out the employment status of workers.
Private sector IR35 reform from April 2020
In May 2018, HMRC launched a consultation into extending the ‘off payroll’ rules to cover the private sector. The consultation closed on 10th August.
At the October 2018 Budget, the Chancellor confirmed what many in the contracting industry expected – the off-payroll rules will be extended to most private sector businesses from April 2020 onwards.
A fresh consultation will be launched shortly to work out how these changes will be implemented in reality.