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What is IR35?

IR35 was introduced in April 2000 and affects anyone who is working via an intermediary, such as a company or partnership.

What is IR35?

The IR35 legislation is designed to increase both the tax and national insurance to the Inland Revenue from the service industry, which on the whole has found it more tax efficient to distribute income as dividends, usually subject to the payment of a small salary.

The governments concern is that small limited companies are being used to disguise employment, so this is the test which has been applied:

Where the employee is provided by his/her Company to an ultimate client on terms which would normally constitute an employment with that client, this is called a relevant engagement and the IR35 rules apply.

Those contractors who fall under the IR35 rules will be liable to Schedule E taxation and national insurance, following deductions for expenses. Income will be in the form of a ‘deemed payment’, following these deductions. Contractor companies may have a mixture of IR35 and non-IR35 turnover, in which case income and reward associated with unregulated contracts will escape these rules.

What is the financial impact of IR35?

The financial impact on contractors caught by IR35 is significant, resulting in the payment of more tax.

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/her 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.

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.

Beating IR35

There are several ways of not being included in the IR35 legislation:

  • The ideal position is to show that you are self-employed as per the Inland Revenue definition of the term. This will require an IR35 friendly contract, with working practices which match those stated in the contract.
  • Work Overseas. Aside from a better climate, cheaper accommodation etc that can come from working overseas, some countries also offer tax incentives. For example, countries such as Dubai operate a tax free environment, meaning that you get to keep 100% of whatever you earn. Whichever country you decide, be aware that overseas tax laws are equally if not more complex than those in the UK. Before making the move it is worth consulting a tax specialist otherwise you may end up being less financially well off then you would have been in the UK.
  • Do nothing. Many contractors have not addressed the IR35 issue – either hoping that legislation will be revoked, or believing that it will not apply to them. This is obviously not a recommended approach. IR35 is law and all contractors caught by the rules should make arrangements to meet the increased financial burden.

If you are unsure on whether your contract falls inside or outside of IR35 you should be able to ask either your contractor accountant to review it on your behalf or ask your umbrella company if you are using umbrella companies.

Contractor UK has a comprehensive section on IR35, including information on how to know if you're inside IR35 and the factors determining employment status in IR35. There is also detailed coverage of the IR35 review.