The basics of IR35
What is IR35?
IR35, also known as the Intermediaries Legislation, is concerned with the employment status of an individual with an end client, and consequently the treatment of tax and NI on the arising income. IR35 was introduced to prevent individuals paying less tax by providing services through a limited company, as opposed to being on the client’s payroll, when, in effect their contract was, in most respects that of PAYE employment. If your contract is inside IR35 the relationship is effectively one of disguised employment and you will have to pay employed levels of tax and NI on your income.
IR35 is not only concerned with the contents of a written contract, but also looks at the actual working practices. When the working practices do not reflect the contractual terms, the working practices will take precedence over the terms of the contract. There are many aspects to consider when determining whether a contract is subject to IR35, but the two most important factors are control (right of) and personal service (right of substitution). If the client has no right of control over the manner in which you carry out your work and you have the right to either send a substitute worker in your place, should the need arise, or sub-contract some of the work or engage other workers to assist you, then it is likely that your contract will fall outside of IR35. Control and personal service are key areas in IR35 decision making; however, if your status cannot be determined on these criteria, there are a number of other considerations which build up a picture to determine your status.
Factors to take into consideration
Right of Substitution
If the end client hasn’t or wouldn’t agree to the worker’s business arranging for a paid substitute to work instead of them, it suggests that they’re being engaged on a personal service basis.
If the end client has a right of control over what the worker does during the engagement, this would suggest the working practices are similar to those of an employee. Does the end client have the right to decide how the work is done, can they move the worker to a different task or decide when or where they work?
HMRC will look at the level of financial risk taken by the worker during the engagement. Workers who don’t risk their own money are more likely to be employed for tax purposes. HMRC will look at what equipment or materials the worker provides, on what basis the remuneration is determined and whether the worker corrects any unsatisfactory work at their own cost.
Part and parcel of the organisation
Workers who receive benefits, such as sick pay, a workplace pension or health insurance etc, have line management responsibilities for other people or represent themselves as working for the end client are more likely to be employed for tax purposes.
How does IR35 affect me?
If you operate under IR35, you are obliged to take 95% of your fee income, minus allowable expenses as ‘deemed’ salary and pay the appropriate tax and NI on the resulting amount.
Competex will provide IR35 salary calculation templates where you can enter your sales income and your expenses and it will calculate the resulting IR35 salary.
The 5% that is retained in the company can be used to pay expenses not allowable under IR35. You are not able to claim travel and subsistence expenses, considered as commuting i.e. from home to your normal place of work.
Being under IR35 restricts your ability to take dividends out of your company.
Off payroll working in the public sector
New legislation was introduced in April 2017 for those working under IR35 in the public sector. For these contractors, it is the public sector body who will have the responsibility of deciding whether the contract is inside or outside of IR35. For those contracts inside IR35, the end client (or agency, if there is one) will have the responsibility of operating PAYE. Tax will be deducted at a straight rate of 20% and the net pay will be paid into the contractor’s limited company. Any monies (from this payment) taken out of the limited company account, as salary, will need to be processed again on a Nil tax/NI basis through the PSC’s payroll. It is important to note that additional tax may be payable on this salary via your tax return. Please note that even if you are taxed at source you will not receive employment rights through your end client or agency.
Working under IR35 in the public sector does not allow you to claim the 5% allowance (for paying expenses).
If a contract is likely to be only short term or a one off then working via an existing personal service company might be the simplest for you. If you are entering into a longer term contract, or you think you will be undertaking similar IR35 positions in the future, then it would make more sense to explore using an Umbrella company. It appears that many agencies and public sector bodies are not set up to administer the payroll process or find it cumbersome to operate. Therefore the solution would be to operate through an umbrella company. This omits the need to process the salary twice (with the associated costs) and simplifies the process. Using an umbrella company means that the right amount of tax and NI is deducted at the point you are paid and you may also deduct certain expenses from the salary calculation. Some agencies are offering two day rates; one for operating through your limited company and a slightly higher day rate for utilising an umbrella company.
What is an umbrella company?
Instead of working through your own limited company you are employed by an umbrella company. The umbrella company issues you with an employment contract, you negotiate your contract directly with your agency or end client and the umbrella company then contracts directly with your agency or end client. When your end client approves your timesheet the umbrella company invoices the client or agency. Therefore, instead of taking salary through your limited company payroll, you are under PAYE through an umbrella company.
Competex Umbrella Ltd offers a fully compliant umbrella service, paying allowable tax free expenses, pension contributions and salary sacrifice arrangements.
The ESS tool
HMRC have devised an online tool which will assist in establishing your IR35 status. They have confirmed that, if you answer the questions accurately, and the tool delivers an ‘outside IR35’ result, HMRC will stand by that decision. After completion, you can download and save a copy of the test. HMRC do not keep a copy of your assessment. If your working practices change it is important that you re-do the assessment.
It may be that the tool cannot determine your status, and if this occurs, you will need to obtain an IR35 contract review. Please note that if you are working in the public sector the responsibility of determining your status lies with the end client.
To sum up
If you provide your services through a limited company, you need to determine your IR35 status for each contract you undertake, including extensions and renewals. Don’t ignore IR35. HMRC have specialised teams investigating IR35 status and if you are found not to be operating IR35 when you should have been, HMRC will charge for all the underpaid tax and NI (plus interest) and impose stringent penalties.
Next resource: Calculating your salary under IR35