A Complex Landscape for Contractors

The IR35 Legislation and Its Implications

IR35, introduced as part of the Finance Act in 1999, aims to combat tax avoidance by identifying individuals who are disguised employees, sometimes called ‘false employees,’ rather than true contractors. While the intentions behind IR35 were to curb false self-employment and protect tax revenues, its implementation has caused significant confusion and controversy within the contractor community.

What is IR35?

IR35 was created to address a genuine taxation issue where employees could leave a company only to return as contractors using a limited company, accruing the taxation benefits this offered.

Key Points of IR35

There are several criteria that define whether a contractor is ‘inside IR35’ or ‘outside IR35’:

1. Control: If your client controls how you work (e.g., your hours, tasks, or dress code), it looks more like employment than contracting.
2. Substitution: Genuine contractors should be able to send someone else to do their work if they can’t. Employees typically can’t do this.
3. Mutuality of Obligation: Employees usually have a guaranteed workload. Contractors should not have this expectation from their clients.

Impacts on Contractors

• Financial Hit: If you’re caught by IR35, you have to process your income through PAYE (Pay As You Earn), which reduces the tax benefits you get from using a Limited Company. This change makes contracting less financially appealing.
• Lack of Benefits: Despite paying similar taxes to employees, contractors don’t get employment benefits like holiday pay, sick leave, or job security if they are under IR35.
• Extra Taxes: Contractors often have to pay Employer’s National Insurance (ENI), which adds to their financial burden. This tax is usually paid by employers but falls on contractors under IR35.

Using Limited Companies

Many contractors use Limited Companies to benefit from lower tax rates on dividends compared to salaries. This method allows them to pay less tax overall. However, IR35 challenges this benefit by making affected contractors pay through PAYE.

Risk and Reward

Contracting through a Limited Company comes with risks, such as no employment rights. However, it also offers potential tax advantages as a reward for taking these risks.

Compliance and Testing

HMRC offers a tool called CEST (Check Employment Status for Tax) to help contractors check if they fall under IR35. However, this tool has been criticized for not being comprehensive enough. Contractors should also review their working practices independently to ensure they are compliant.

Industry-Specific Risks

Some industries, like the NHS, have high levels of control and obligation, making it easier for contractors in these sectors to fall under IR35.

Moving Forward

The extension of IR35 to the private sector in April 2021 mirrored the public sector’s experience since 2017. Contractors need to reassess their work arrangements to stay compliant.

Using Umbrella Companies

Many contractors might turn to umbrella companies, which handle PAYE on their behalf. While this can simplify compliance, it comes with its own costs and considerations.

Key Takeaway

IR35 remains a complex and controversial piece of legislation that significantly impacts contractors. Understanding its details and preparing for compliance is crucial for anyone in this line of work.