Introducing IR35 (And How Umbrella Companies Can Help)
With hefty fees for non-compliance, it’s essential for contractors to understand IR35 and umbrella companies. In short, IR35 legislation is used to distinguish between companies providing a service to clients and people who are essentially employed by those companies. But there are plenty of ins, outs and tricky points to be aware of, including the role of umbrella companies. Confused yet?
Don’t be caught out. Read on for the Umbrella Broker guide to IR35, your status and how umbrella companies could help.
A short history lesson in IR35
The road to IR35 started in the 1980s. When HMRC introduced a rule making recruitment companies liable for any tax errors they made prior to paying contractors. It made working with self-employed contractors far riskier for recruitment companies, with many subsequently refusing to deal with them.
To continue working with recruitment companies, contractors began setting themselves up as limited companies, for which recruitment companies held no liability. This also meant they could pay themselves in dividends, which are subject to lower rates of income tax and exempt from national insurance contributions.
Understandably, this meant HMRC was taking significantly less tax from the market. The new system also enabled companies to effectively ‘hire’ limited companies without the usual responsibilities as an employer. To counter these issues, they introduced IR35 in 2000.
What is IR35?
Also known as the Intermediaries Legislation, IR35 aimed to establish a contractor’s true employment status. So, those who were operating through limited companies – known as ‘intermediary companies’ or ‘intermediaries’ – would still have to pay tax and national insurance under traditional employee rules.
Since its introduction, it’s become hugely important for contractors to assess their status. Operating through an intermediary and paying less tax and national insurance may seem beneficial. However, any savings will likely have to be paid back. In most cases, this is further down the line when you don’t have anything close to the full amount readily available.
Who is in and who is out?
With that in mind, it’s important to determine whether you’re operating inside IR35 or outside of it. Unfortunately, there is no clear way to tell because IR35 has no set definition for a case which is inside or outside of the regulation. To assess your status, HMRC provides status tests online.
The tests can be used by an agency placing a worker. An organisation hiring a worker. Or a worker themselves who is providing a service. They cover several different aspects of the working engagement:
- Responsibilities of the worker
- Who decides what the worker needs to do
- Who decides the terms of work – when and where it’s done
- How the worker is paid
- Whether the work engagement includes any expenses or benefits
These criteria help determine who is in control of the worker. When there is a right to exercise control over a worker, they are likely to be classed as an employee. They also assess the right to employ other assistants or substitutes to perform the job. Employees are hired to do the job directly themselves. While truly self-employed contractors may hire someone to do it for them if necessary.
After taking the status tests, you can print your results as a way to demonstrate that you took reasonable care. These assessments need to be completed for each work assignment. If any of your working arrangements change, you will need to check again whether you’re inside or outside IR35.
Why it’s worth checking
As well as avoiding costs further down the line, there are a multitude of reasons to check the IR35 status of contracting work:
- Comparing jobs – If you’re in a position to choose between two or more contracts, IR35 status could be a deciding factor. Jobs that are outside IR35 typically provide more income because of lower taxation.
- Operating structure – Checking your IR35 status could provide better direction for your contracting work. If you’re operating inside IR35, for instance, it may be worth considering an umbrella company. On the other hand, if you’re operating outside IR35, it could be beneficial to set up a limited company.
- Limited companies – If you’re already operating as a limited company, being inside IR35 will determine how you need to receive and pay tax on income.
What about umbrella companies?
A popular way to circumnavigate IR35 is by using an umbrella company. Umbrella companies employ contractors. They then work as an intermediary between them and their clients. This provides a balance between the ‘be your own boss’ benefits of contracting and the simplicity of being an employee.
With an umbrella company, you are classed as an employee. With no need to worry about payroll, accounts and taxation. This means there is no need to determine your IR35 status time and time again. Contracting umbrella companies are fully tax-compliant. You won’t be caught out by any charges in the future.
Invoicing and chasing payments is also taken care of by umbrella companies. This removes stressful and a time-consuming task for contractors. Essentially, they eliminate the cost and hassle of operating a limited company.
Penalties and tax implications
Under IR35, the traditional low salary & high dividend model – used by limited companies – is unavailable to contractors. And if you’re caught by IR35, regardless of whether you’re using a limited company or an umbrella company, you will need to process your full contract value through PAYE.
This means that a Limited Company will be largely uneconomical as it adds an extra cost and administration burden when compared to an umbrella. In the event you fail to process your payments through PAYE, you could be subject to an IR35 fine of up to 100% of the unpaid taxes due. In short, getting your tax calculations right is paramount.
Why an umbrella is the smart move
Whether it’s IR35 penalties or increased taxation from being classed as an employee (even if you have a Limited company), IR35 can significantly impact the amount contractors take home each month. This means using an umbrella company is the smart way to ensure that throughout your contracting career it doesn’t matter whether you’re caught by IR35 or not.
