IR35 can have a huge financial impact on contractors and consultants. IR35 is supposed to deter contractors and consultants from trading through an intermediary (which is normally a limited company) and therefore avoiding tax and national insurance. The tax man would much rather you were a straightforward employee.
Prior to IR35, all contractors and consultants could form a limited company and invoice their “client”/”employer” the usual market rate but crucially, then pay themselves a minimum salary and take the remainder as dividends. This avoids national insurance and and saves PAYE personal tax on the dividend element.
(Update: with the introduction of Dividend Tax in April 2016, the tax saving on dividends has been reduced)
Who is affected by IR35?
Although, traditionally IR35 affected IT contractors and engineers, the legislation is not actually limited to a particular trade, occupation or business sector.
If you personally perform services for your customer, through an intermediary, you may be affected by IR35 (also called, “being inside IR35”) if you could be deemed an employee of your customer if it were not for the existence of the intermediary.
Are you inside or outside IR35?
HMRC publishes an introduction and a list of guiding questions to help you to decide whether you fall inside or outside IR35.
You will need to examine whether IR35 applies on a “contract by contract” basis. It is possible to have some contracts within IR35 and some outside IR35.
The circumstances of your “intermediary” is also a factor. For example, if the intermediary is a limited company – who owns the shares and in what proportion?
The wording of your contract and your working practices are also factors – although there is no such thing as an “IR35-proof” contract. In the event of an enquiry, HMRC would examine the reality of your situation, not just your written contract.
If you are a “borderline” case, it may be worthwhile consulting an employment law specialist to examine your contract, working practices.
(“Inside IR35” – IR35 legislation applies to your circumstances
“Outside IR35” – IR35 legislation does not apply to your circumstances)
The Consequences of Being Inside IR35
The financial consequences of being inside IR35 are mainly (there are other consequences) you lose the tax-avoidance facility of dividends and you pay two sets of national insurance employees national insurance and employers national insurance.
Essentially, if you are within IR35, you must calculate a “deemed payment” and pay NICs and PAYE (tax) on that deemed payment.
The tax-deductible amounts that you can claim in travel and expenses will also be limited.