Financial Impact of IR35 on IT Contractors

If an IT Contractor's work is deemed to fall under the IR35 rules, the financial impact in terms of tax liabilities is considerable compared to those of a Contractor who falls outside the rules.

The IR35 rules target circumstances where a "worker" would be treated as a normal employee of the client, if it were not for the existence of the intermediary (the Limited Company).

A Limited Company contractor who falls outside the IR35 rules would typically withdraw a modest salary (net of employers + employee's NI, and income tax), with the bulk of income being derived from dividends.

For a contractor caught by IR35, all his yearly income to the end of the tax year will be treated as a salary (or "deemed payment"). Income Tax and National Insurance will be due on the entire amount - paid throughout the year.

Alongside standard Section 198 expenses (e.g. pensions payment, professional subscriptions, professional indemnity insurance), the Inland Revenue has also provided a standard "5% allowance" to cover the running costs of a limited company.

Corporation Tax and VAT are calculated in the normal way, regardless of IR35.

The difference in the take-home pay between a contractor inside IR35 and another outside is significant. For this reason, contractors should always seek professional advice before signing a contract, and ensuring that their contracts satisfy the Inland Revenue's definition of "self employed" work as per the IR35 employment status rules.