What is IR35?
The Intermediaries Legislation, or IR35 as it’s more commonly known, is the most important tax law affecting you as a freelancer or contractor. The aim of IR35 is to prevent an individual, who would ordinarily be viewed as an employee, offering his or her services through a Limited Company to avoid paying Income Tax and National Insurance Contributions.
So, in simple terms, if you as an individual enter directly into a contract with an employer, you’ll receive a salary that would be subject to Income Tax of up to 45% and National Insurance Contributions of up to 12%.
Now, when a Limited Company enters into the same contract, the tax rules are different. This is because a Limited Company will not be viewed as receiving a salary. Instead, it will make a profit, on which, it will pay Business Tax of only 19%. Furthermore, it will not be subject to National Insurance Contributions at all. To prevent every employee from setting up their own Limited Company in order to avoid National Insurance and the potentially higher levels of tax, IR35 was introduced.
Why is there uncertainty as to whether or not IR35 applies to my contract?
Whilst IR35 is a tax law, in order to determine whether or not to apply IR35, you need to understand employment law. This will allow you establish whether you’d be regarded as an employee of the end client in the absence of your Limited Company. This is often referred to as ‘disguised employment’.
Unfortunately, employment law doesn’t provide a distinction between employment and self-employment. Therefore, leaving you to rely upon past judgments in common law in order to reach your decision.
What are the criteria to indicate that I am an employee or in ‘disguised employment’?
In determining the status of an individual as employed, you’d need to establish that all three prerequisites of employment status are present. That is:
- You’re required to provide the service personally.
- You’re subject to Supervision, Direction or Control over the manner in which the work is performed.
- There’s a mutual obligation of both parties; so your employer is obliged to provide work and you are obliged to make yourself available to do so.
Who decides if I need to apply IR35 to my contract?
If you’re working on a Public Sector assignment, the responsibility lies with your end client. However, if you have a contract in the Private Sector, it comes down to you as the director of your Limited Company. As a consequence, we’d recommend you seek professional assistance before making your final decision.
In order to be deemed as ‘outside’ IR35, will I need to show that I’m in business on my own account (effectively self-employed)?
For IR35 to apply you need to be regarded as an employee of the end client. So, conversely, to remain ‘outside’ of IR35 legislation you need to show that you’re not an employee of the end client. This isn’t the same as showing you are self-employed, although, being able to demonstrate that you are in business on your own account is always regarded as the best option.
How best to remain ‘outside’ IR35:
- Behave like a business: You need to differentiate yourself from the actual employees of your end client. This begins with the contract you sign and how you act on a day to day basis.
- Review your contracts: Don’t sign a contract until you’ve taken professional advice and are satisfied with the IR35 terms and conditions.
- Collect evidence: Keep records of particular events which demonstrate that you acted differently from an end client employee. For example, during an IT failure you went home and received no pay, when all employees remained.
- Market your business: Choose a business name, create your own logo and business stationery. Sell your services via your company’s website.
- Understand the business sector: Take advice to ensure that you’re aware of any special rules that may apply in your sector, which mean IR35 applies automatically.
What are the conditions needed for IR35 to apply to my contract?
If certain conditions are met under IR35, then the earnings of the company are considered to be a ‘salary’ on which Income Tax and National Insurance Contributions are payable.
IR35 applies where the following 3 conditions are met:
- An individual performs services for a client.
- These services are provided under a contract involving a Limited Company.
- If the services were provided under a contract directly between the individual and the end client, the individual would be regarded as an employee of the end client.
One exception to these conditions is in relation to being an ‘Office Holder’. By simply being an office holder of your end client, IR35 will apply; there is no need to consider condition 3.
DID YOU KNOW … the conditions for IR35 to apply are based upon a contract, and not your Limited Company. So, during your contracting life you may find IR35 applies to some contracts and not others.
If IR35 does apply to my contract what does this mean?
If IR35 applies, your company will have to pay Income Tax and National Insurance Contributions that it wouldn’t have otherwise had to pay. As Income Tax and National Insurance Contributions are more usually associated with a salary rather than business income, IR35 includes a calculation to convert contract income into a taxable salary amount known as a ‘deemed salary’.
Will I continue to receive tax relief on expenses?
For IR35 purposes, expenditure falls into three categories:
- General administration expenses (Private Sector only): An allowance equal to 5% of the total IR35 income is deducted rather than the actual cost incurred. This allows for the general expense of running a business, such as accountancy fees and marketing costs.
- Other expenses (including travel & subsistence): These are expenses which you could have claimed as a deduction if you’d been directly employed by the client. For example, travel costs between workplaces, professional subscriptions and Professional Indemnity Insurance are all allowable deductions.
Note: operating under IR35 will mean that your workplace is no longer considered temporary. As such, home to work travel is not allowable as a deduction.
- Capital allowances: You’re only allowed to make a deduction for capital allowances where the plant or machinery bought is necessary for the performance of the contract within IR35. Examples include the cost of a computer or laptop.
Calculating your ‘deemed salary’ under IR35
This may be easier to explain with a simple example…
Eric is an engineering consultant with his own Limited Company, E.E.C. Limited, who completed a Private Sector contract to which IR35 applied. The income received from this contract amounted to £60,000 and Eric incurred £1,000 in travelling between workplaces whilst fulfilling this contract. In addition, E.E.C. Limited paid £250 for Professional Indemnity Insurance, £150 for Eric’s professional engineering subscriptions, and £5,000 into Eric’s pension.
So, Eric’s deemed salary calculation is as follows:
- Contract Income £60,000
- Company Administration Allowance* (calculated as 5% of contract income) £(3,000)
- Costs incurred in performing the contract (e.g. travel between workplaces) £(1,000)
- Allowable costs paid to an employee (e.g. professional subscriptions) £(150)
- Business insurance premiums £(250)
- Payments made to an approved pension scheme £(5,000)
- Subtotal £50,600
Nearly there – the figure in subtotal ‘G’ represents the ‘deemed salary’ plus the associated Employer’s National Insurance.
- Employer’s National Insurance £(5,089)
- Deemed Salary £45,511
So, from a contract income of £60,000, a gross salary of £45,511 must be declared. Furthermore, the associated Income Tax and National Insurance paid by the company to HMRC.
Note: don’t forget that the Employer’s National Insurance of £5,089 is also payable to HMRC.
For more information on IR35 get in touch here.