A guide to IR35
IR35 is a tax legislation that was brought in to prevent workers from falsely claiming to be contractors to pay less tax.
Paula Tomlinson FCA CTA from On The Spot Accountants explains the key things you need to be aware of as a freelancer or contractor.
1. What is IR35?
IR35 is the name HMRC gave one of its press releases in 1999 when HMRC was known as the Inland Revenue (IR). The government was concerned about the increase of single director-shareholder limited companies working long term for their clients in a way that was more like an employee-employer relationship than a normal supplier-client relationship.
Individuals who provide their services through their own limited companies can be called consultants. But they may perhaps be better referred to as contractors or freelancers. IR35 also applies to partnerships, but it does not apply to sole traders.
2. Why was IR35 brought in?
A lot of tax - largely employer national insurance - can be saved by providing a service through a limited company. IR35 was established because the government became concerned about the growing loss of higher employee tax revenue against the lower corporation tax revenue.
When starting work with a client, the consultant company - possibly with accountancy advice - decides whether there's an employment relationship and therefore whether to apply IR35. If IR35 is applied, the consultant company pays tax equivalent to that of an employee, i.e. more tax than they would pay as a consultant/supplier. Therefore, they will be reluctant to classify themselves as an employee.
In addition, both consultant and client may like the idea of flexibility and of not being tied to each other. A consultant can be engaged for a single project, or period of time, and then ask to leave at the end without any obligations. It may be argued that a dynamic economy requires this sort of flexible working, but perhaps has the downside of not providing a safety net for illness or redundancy.
The clients are often large private sector corporates and the public sector.
3. The impact of IR35 on the public sector vs. impact on the private sector
The same rules as to whether IR35 applies has always been the same for both the public sector and private sector.
To help combat the increasing amounts of lost tax, in April 2017, HMRC introduced the concept of ‘Off-payroll working' for the public sector. They also put the responsibility on the public sector to review its contracts and arrangements with consultant companies to establish whether they should be taxed as an employee.
HMRC provides an online Q&A tool, called CEST: Check Employment Status for Tax, to help the public sector decide the result. However, this tool has been found to be flawed in certain situations and, together with its general cautious approach, the public sector has put a lot of consultants into ‘Off-payroll working'.
Generally, the rate of pay didn't change. So, the consultant company suffers the additional tax, but, usually, without any increased employment rights.
From April 2020, large and medium sized corporate clients will be in the same position as the public sector. The private sector may be less cautious and stand its ground with some consultant companies. However, the climate has changed, and we are seeing several corporates asking for its contractors to move to full employment contracts or face no further work at the end of their current contracts.
4. What do freelancers and contractors need to do because of the legislation?
You need to agree with your public and private sector clients whether you are caught by these rules. It's not essential to rely on HMRC's CEST tool, but it can help if the result agrees with yours and your client's understanding of your business relationship.
As a general rule, you and your clients need to demonstrate that you are like any other 3rd party supplier. For example:
- Other people from your company may be sent to your client, i.e. ‘substitution'
- There is no ongoing mutual obligation to provide work to you or for you to accept it
- Identify a project-based piece of work, rather than payment by the hour or day
- Your company has to correct your mistakes in your own time
- Your company pays its own insurance, advertising and bad debts
- Your company has its own website, VAT registration and equipment
You may decide to work only for small private sector clients, where the decision as to whether IR35 applies remains with you and you don't need to discuss it with your clients. The above list of factors still remain relevant for you to consider.
5. Anything else that freelancers and contractors need to know
This area of law is developing through employment and tax tribunals, so keep an eye on developments in the press, taking appropriate advice for your situation.
When you work as a freelancer or contractor, you're responsible for dealing with any disruptions to your work life. If something goes wrong, you won't be able to rely on your manager or an in-house legal team to fix the problem. That's why it's important to safeguard your finances.
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