If you’re currently working as a contractor or you’re looking to form an organization that connects businesses t contractors, IR35 is a tax structure that you will need to acclimate yourself with. It is a set of legislation that was built to change the landscape of contracting as of April 2020, although it is currently on hold. Still, there are high hopes that the government will pass it eventually.
Ideally, contractors who work through companies can benefit immensely from certain tax advantages. However, IR35 changes how this works, ensuring that contractors who work the same as part-time or full-time employees have to pay the same national insurance and tax as those employees.
With the tax season drawing easter, it’s critical to understand how these rules work and what they mean for contractors especially. Let’s dive into the topic:
Understanding IR35
Known by many as the “Intermediaries Legislation,” IR35 is an off-payroll working tax legislation. It was designed to identify contractors and businesses who use these contractors for tax avoidance purposes. By law, contractors aren’t under the same tax obligations as full-time employees. At the same time, companies who hire these people don’t necessarily have to pay their full payroll taxes as well.
How IR35 Affects Contractors
According to the experts, IR35 is closely tied to contracting. If you work as a contractor through a limited company, you will be able to pay 20 percent of your profits as corporation tax. You can also use business costs to offset some of that tax bill and pay yourself through dividends to work around the National Insurance Contributions (NIC).
Working as a contractor can be seen as a more tax-efficient route than working through a company or as a company employee with all these loopholes.
In reality, many contractors are working the same way as employees but intentionally or unintentionally gain a tax advantage over some who work the same way. With IR35, the government is looking to remove this tax advantage and provide a level playing field for everyone. At the same time, the legislation is set to increase government tax revenues. So, everyone seems to win.
Working Inside IR35
Essentially, operating “inside IR35” means that you will have to pay the same taxes as an employee under IR35 legislation. Note that this could also make you eligible for additional employee and worker rights – such as protection from discrimination, maternity leave with pay, sick leave, health insurance, minimum wage, and more.
Working inside IR35 generally means you will have to make an income tax payment at the end of the year to account for any NIC or tax deductions that full-time employees have also paid.
Working Outside IR35
Operating outside IR35 means that the legislation doesn’t prevent you from paying private-sector taxes. So, you can pay yourself a salary and take out any additional income as dividends. At the same time, your company will only pay a 20 percent tax on profits per the corporate tax rates.
Some of the factors that could indicate working outside IR35 include operating your own business insurance, working for multiple clients, hiring your dedicated equipment, and more. As a contractor, you must get tax advice specialists who will provide detailed advice on your IR35 status. Usually, this service involves reviewing your service contracts and daily working practices.
The Test of Employment
Since IR35 looks to change the tax structure of viable businesses, it is underpinned by employment legislation. Thus, there are certain tests of employment that apply to understanding how the legislation works.
Primarily, an HMRC inspector will try to look into the actual working nature between the contractor and the client to create a “notional contract.” From there, a tribunal judge or an inspector will use the notional contract to determine whether the relationship between both parties is one of employment or one for business-to-business services. While IR35 applies to the former, it doesn’t apply to the latter.
Determining whether IR35 will apply to you takes a great deal of work. It is a complex process, and you will need expert knowledge of employment law. It is recommended that you get specialist IR35 advice to know if there are workarounds or you will need to change your tax structure.
How Can Companies Avoid IR35?
There is no way for firms to circumvent IR35 apart from hiring all contractors on fixed employment contracts. This step will mean hiring contractors as if IR35 actually applies and paying the additional employment taxes.
However, this will be an expensive strategy, and it is unlikely that a firm will be able to renegotiate their preferred rates with all existing contractors to offset the new rules.
For firms that hire self-employed contractors, IR35 doesn’t apply. Note that this doesn’t prevent HMRC from launching an inquiry later into your relationship with these contractors. That process alone will be costly and time-consuming.
Possible Delays to IR35
As explained earlier, IR35 was delayed from April 6, 2020, due to the coronavirus pandemic. The new regulations were deferred by precisely a year. The government already confirmed that it has no plans to delay the legislation any further. So, IR35 is here to stay, and it will be necessary for businesses and contractors alike to prepare for it and what it might mean for them concerning their tax payments.
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