You may vaguely be aware of IR35, never heard of it or already know all the intricacies of it. In essence it is a mechanism for HMRC to address potential pseudo-employee situations which deprive HMRC of tax payments. This was to address a trend in the 1990s when a large number of IT professionals became contractors. The following is a theoretical example:
Holly is a developer in Newbury for a software company, Orange Ltd. She enjoys her job would like to be paid more, she approaches her boss to request a pay rise. He would like to give Holly a pay rise as she is fantastic employee; however, he is restricted to how much he can pay her due to the pay grades in the company. He offers her an alternative to a pay rise; would she like to become a contractor instead and charge a daily rate which is higher than the top of her current pay grade. Holly is happy with the suggestion; she resigns from Orange Ltd, and signs a contractor contract. Due to advice from a colleague she sets up a limited company – Holly IT Ltd.
If Holly continues to work in the same way for Orange Ltd, and is treated just the same as any other employee she has a potential IR35 situation. She may think that it is fine to pay herself a small salary from Holly IT Ltd and extract further money as dividends. However, HMRC may consider this an IR35 situation, in which case 95% of the revenue Holly IT Ltd should be paid to Holly via payroll, thus paying full employee and employer national insurance. If this happens, her “pay rise” may not look so attractive.
When HMRC review a contracting situation they are looking for various indicators, the following is an extract from the HMRC website that helps you to decide whether your contract falls under IR35 or not.
Would I have been an employee of my client?
The IR35 rules only apply if you would have been an employee of your client, had it not been for the existence of your Personal Service Company or partnership.
If you can answer ‘yes’ to most of the following questions, you would probably have been an employee of your client for the contract in question and therefore within the new rules.
- Do you work set hours, or a given number of hours a week or a month?
- Do you have to do the work yourself rather than hire someone else to do the work for you?
- Can someone tell you at any time what to do, when to work or how to do the work?
- Are you paid by the hour, week or month?
- Can you get overtime pay?
- Do you work at the premises of the person you work for, or at a place or places he or she decides?
- Do you generally work for one client at a time, rather than having a number of contracts?
If you can answer ‘yes’ to most of the following questions, you would probably not have been an employee of your client and therefore outside the new rules.
- Do you have the final say in how you do the work for the client?
- Can you make a loss on the contract?
- Do you have to provide the main items of equipment you need to do the job for the client, not just the small tools many employees provide for themselves?
- Are you free to hire other people on your own terms to do the work you have taken on?
- If you are free to hire other people on your own terms, do you pay them out of your own pocket?
- Do you have to correct unsatisfactory work in your own time and at your own expense?
- Do you have a number of clients at the same time?
You will have to think about each contract individually. Some people will find that they have some contracts, which would have been employment and so come within the rules, and others which do not.
If you are concerned that your contracts may fall under IR35 we recommend the following steps:
- Take an online IR35 test, there are many websites that provide this service.
- Request an IR35 contract review from your accountant.
- Reduce the risk of falling under IR35 by requesting contract amendments to be compliant, these changes need to be followed up in practice as well not just on paper.
- Consider taking out IR35 insurance, this can potentially cover future tax penalties, tax charges and professional representation in case of a dispute. All Goringe Accountants Ltd clients are already covered for professional representation for inspections, enquiries etc. however, long-term contractors may consider bespoke IR35 insurance.
- If it is clear that you are definitely a pseudo-employee then you should ensure that you adhere to IR35 and pay the correct NI and income tax.
The IR35 legislation may of course be reviewed, revoked or accentuated. Many small business owner lobbying groups campaign for the IR35 legislation to revoked, as it can be murky for some situations and is another piece of red tape for businesses. However, for now make sure you aren’t at risk of a nasty retrospective tax bill with penalties. We recommend getting expert advice if you believe you are at risk.
Nicky Goringe Larkin is a Chartered Management Accountant who founded Goringe Accountants Ltd.
Tags: accountant accountants dividends HMRC income tax inland revenue insurance IR35 IR35 rules limited company penalties salary tax tax payments
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