The term ‘IR35′ is derived from the number of a 1999 Inland Revenue press release (now HMRC) – entitled ‘Countering Avoidance in the Provision of Personal Services’.
The release signaled the Treasury’s plans to clamp down on what was seen as the avoidance of National Insurance Contributions by individuals using limited companies to perform work for clients, where ordinarily their working practices were the same as employees. The Inland Revenue used the example of ’9 to 5′ IT workers who would end the week working as employees on a client site, only to return the following week as limited company contractors.
‘IR35′ became law via the Finance Act 2000, and has remained in place ever since, despite much opposition from within the contracting community who see the rules as targeted, unfair and hard to understand.
Are you inside or outside IR35?
In determining whether an individual’s contract is deemed to be subject to the IR35 rules or not, HMRC need to establish whether that person is ‘employed’ or ‘self employed’, using both his working practices and the physical contract.
An IT contractor who performed his work in an identical way to regular employees on the end client’s site, used the client’s equipment, and could not provide a substitute, is likely to be seen as ‘employed’.
However, a contractor who has control over the work he does, uses his own equipment, and has a number of clients, is more likely to be seen as ‘self employed’.
Clearly, it is in every contractors’ best interest to ensure their contracts fall outside the IR35 net.
The HMRC guidance on employment status should help establish whether or not your contract work will be caught by IR35.
What if you are caught by the IR35 rules?
Limited company contractors and freelancers whose contracts are caught by the IR35 rules will draw down income from their companies in the form of a ‘deemed payment’ (akin to a normal ‘employee’), plus a an expenses allowance equal to 5% of turnover to pay for things like professional indemnity insurance and executive pension contributions.
Limited company contractors who are outside IR35 can pay themselves a small salary and then draw down the rest of their income in the form of dividends. This is a very tax efficient way of contracting, as income tax and National Insurance Contributions are minimised.
Clearly, there is a dramatic difference in taxation levels between those caught by IR35 and those who are not.
IR35 applies to the contract rather than the contractor, so you may well work on some contracts which fall outside the IR35 rules, and others which do not. HMRC look at the overall picture when determining IR35 status – this includes the ‘working practices’ of the contractor, as well as the wording of the paper contract(s) which exist between the contractor’s limited company, the recruitment agency (if relevant), and the end client.
As a result, we strongly recommend that you have your contracts professionally reviewed by employment status experts before signing.
Some of the leading IR35 contract review service providers include:
What is the current situation (2011)?
At the 2011 Budget, the Chancellor announced that the IR35 rules are to remain in place, following recommendations from the Office of Tax Simplification.
Despite high hopes within the contracting community, the Government felt that it stood to lose a substantial amount of tax and National Insurance revenue if IR35 were to be abolished.
Alongside other measures, HMRC has been tasked with improving the way it administers the Intermediaries Legislation, to provide more certainty to contractors.
We recommend that contractors consider taking out IR35 insurance to protect them in the event of a status review by HMRC. This type of policy provides peace of mind, for very little outlay.
For dozens of in-depth guides to IR35, try our dedicated site for contractors and freelancers – Contract Eye.