If you’re a professional contractor – working via your own company – you will have heard of IR35. If you’re caught by this tax legislation, it could have a big impact on your take home pay. So what does inside and outside IR35 actually mean?
What is IR35?
This legislation, first implemented in 2000, is aimed at taxing ‘disguised employees’ in the same way as all other employees.
The rules were aimed mainly at IT workers who would leave a permanent role but return to the same or similar roles as a limited company contractor. This is a more tax efficient way to work, although the tax savings have reduced massively in recent years.
If your contract work is deemed to be ‘inside IR35’, then you will be taxed like a regular employee.
New ‘off payroll’ rules were added in 2017 and 2021. These rules place the burden of working out if a contractor falls within the IR35 trap or not in the hands of clients.
So, unless your client is a ‘small company’, then they are in charge of determining your employment status. Before the off payroll rules were implemented, this obligation was met by the contractor himself.
What does it mean to be inside IR35?
If your contract work falls inside IR35, it means that you are considered to be an employee for tax purposes. This means that your contract income will be subject to PAYE (Pay As You Earn) tax and National Insurance contributions, just like a regular employee.
There are a number of factors that HMRC will consider when determining whether you are inside or outside IR35, including:
- The degree of control that the client has over your work.
- If you’re able to use a substitute.
- The equipment and resources that you use
- If your client is obligated to provide more work after a task has been completed.
- Your ability to take on other work
What does it mean to be outside IR35?
If you are outside IR35, it means that you are considered to be self-employed for tax purposes. This means the profits generated via your limited company are taxed in the same way as any other incorporated business.
Company directors typically draw down profits in the form of a small salary plus dividends.
How to determine your IR35 status
The rules which determine IR35 status are complicated. An individual’s employment status is determined by looking at the wording of their contract, as well as the way they carry out the work (known as working practices).
For most contractors, the task of working out a worker’s status is down to the end client. They can use a variety of methods to help them make the decision – both third party software, and the (much maligned) official HMRC CEST tool.
What happens if I am inside IR35?
If you are found to be inside IR35, your client will be responsible for deducting PAYE tax and National Insurance contributions from your contract income. They must also provide you with a Status Determination Statement, which contains their decision.
What happens if I am outside IR35?
If you are found to be outside IR35, your contract income is subject to standard business taxes (Corporation Tax). You also pay personal tax on any profits you distribute – in the form of salary (income tax and NICs), and dividends (dividend tax).
What can you do to remain outside IR35?
- Use free online tools to assess your current status. For most contractors, the client is now responsible for determining your status, but you should also be proactive – and be prepared to make changes should they be required to remain outside IR35.
- Pay for a professional IR35 contract review. This isn’t expensive and can help identify any changes you should make to both your contract wording and your working practices.
- Negotiate any necessary changes with your client and recruiter (if possible).
- Ensure a confirmation of arrangements document is signed. Some clients may be reluctant to do this, but it is a strong indicator of your outside IR35 status.
- Adhere to compliant working practices throughout the contract. Don’t act like a permanent employee, and collect evidence of your contractor status.
- Consider taking out IR35 investigation insurance. This is particularly important if your company remains responsible for IR35 – i.e. you work for a small company in the private sector.
And finally, make sure you keep a paper trail of all of these activities, in case you need to demonstrate that you have taken steps to demonstrate your outside IR35 status.
For ultimate peace of mind and defence in the event of an IR35 investigation, take out Qdos’ award-winning IR35 insurance – from just £99 per year. This covers up to £50,000 of professional representation and potential tax liabilities up to your chosen level of indemnity.