08. Aug 2019 |
Whether you’re an independent contractor or a business owner considering hiring one, it’s important to have a basic understanding of employment tax law – and IR35 is no exception. Also known as “Intermediaries Legislation,” IR35 was developed to prevent tax evasion by “disguised employees,” or employees paid through an intermediary, such as their own limited company, for the purposes of avoiding income tax.
The legislation was announced on March 9, 1999 as “Island Revenue” press release number 35 – which is where the acronym comes from. Contractors who operate under limited companies don’t have to pay National Insurance tax, since they receive the majority of their pay as dividends. Companies who hire contractors this way also save employers NI, and don’t have to provide the same benefits they would to a bona fide employee. Since there are tax advantages on either side, some people who might have otherwise been employees had been set up as independent contractors instead. IR35 was introduced to allow HMRC to define a working relationship as employer-employee and therefore collect taxes owed on the income the employee has earned.
If the company doing the hiring is in the public sector, they are responsible for paying taxes owed on the earnings; if the arrangement is with a private sector company, the responsibility lies with the contractor. However, this legislation is due to change in April 2020, meaning private sector employers will be held responsible for knowing the IR35 status of their contractors – so any business owners that pay for contract work should brush up on their knowledge of this law.
If you’re doing the exact same work you’d be doing as an employee, but being paid through a limited company and don’t pay NIC, you may be subject to an investigation by HRMC to determine if you owe taxes. If an IR35 investigation determines that the contractor is actually an employee, the employer or contractor might be subject to paying up to six years of back taxes in addition to penalties. To avoid this, it’s important to take some precautions to figure out whether or not you or the contractor you are hiring meets the definition of “employee” under IR35.
There is a set of specific criteria that HMRC uses to decide whether or not a contractor is an employee, based on case law from previous rulings. A basic rule of thumb is that if the working relationship would remain the same if the intermediary (limited company, for example) was removed, then the contract falls under IR35. The following three criteria are particularly key in assessing the working relationship between a contractor and client:
Whether or not you qualify as an employee under IR35 can be a complex question. IT professionals, for example, often have multiple limited contracts in which they do work that an employee might, but only temporarily – so they might look like employees for brief periods of time to HMRC.
Hypothetically speaking, you should be able to operate as a limited company without problems if you’re doing legitimate contract work – however, there have been some high-profile cases in which IR35 was misapplied, so it’s a good idea to be careful. If you have evaluated your contract carefully but still aren’t sure whether or not the work falls under IR35 law, here are a few steps you can take to protect yourself from future hassle:
Contractors that fall inside IR35 have to pay significantly more taxes—but knowing what taxes you have to pay up front is far better than being blindsided by several years of back taxes! Reviewing your contract up front to see whether or not you fall inside IR35 is a good first step, but beware of arrangements that slip too far into employee territory.
And remember: if you’re unsure, find an expert in tax law to help you! The small fee up front may save you much more money in the long run.