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IR35 – The basics explained

Posted on: January 3rd, 2012 by Hardeep No Comments

If you are a contractor or freelancer you can’t afford to bury your head in the sand when it comes to IR35. IR35 is a complex tax legislation that, simply put, is in place to stop contractors using Limited companies to save tax working for a client where ordinarily they would be classed as employees.

How does IR35 affect me?

If you are a contractor working through your own Limited company then you need to determine whether your contract falls outside IR35 or inside IR35 on a contract by contract basis.

Whether you are caught by IR35 or not is all about trying to prove you are in business on your own account as opposed to an “employee” of the client.

The financial difference between being Inside IR35 and Outside IR35 can potentially be huge. If you are Outside IR35 this means that you can pay substantially less tax & NI.

What affects my IR35 status?

Determining your IR35 status is a very complex and specialist process, your contract along with your working process will need to be looked at closely.

Some of the areas that are looked at when deciding your IR35 status are as follow:

Direction & control – How much control does your client have over what, where, when & how your work is carried out?

Provision of equipment – Do you use your own equipment? If you use the clients equipment rather than your own this could point towards employment.

Financial risk – Are you risking your own money buying assets, incurring overheads or running costs? Signs that you are not an employee.

Right of substitution – Do you have the right to use a suitably qualified person to provide the service if need be? An employee wouldn’t.

Mutuality of obligation – Is there an obligation for the client to provide you with work and or for you to accept it? Obligation for work is a basic principle of employment.

This is by no means an exhaustive list and decisions are made by looking at your contract and situation as a whole.

Remember you are trying to prove you are not an employee so avoid things like staff email and phone lists and staff benefits such as gym membership etc. If you want to operate Outside IR35.

What if I am inside IR35?

If you fall inside of the IR35 legislation it means that you have to operate the majority of your pay as salary – “deemed salary” which attracts tax & NI at the same rate as a regular salary.

Even if you operate your Limited company inside IR35 it can still be financially beneficial over an umbrella company as 5% of your income is not subject to tax or NI, some expenses that are not allowed through umbrella companies are allowed through your Limited company plus you can benefit from being registered on the Flat Rate VAT scheme.

What if I get it wrong?

If you operate outside IR35 and you are investigated and HMRC disagree you will have to pay back the taxes as if you had operated a “deemed salary” plus fines and interest.

No one can tell you if you are likely to have a review or not but when they do occur they can be very lengthy and costly affairs. There are companies who will provide you with insurance to negate this risk.

Warning

IR35 is a very complex area and all of the above information has been simplified and provided to give you a very basic understanding of the topic. We would strongly recommend that you seek the advice of a tax status specialist before making any decisions about your personal circumstances. We can recommend some very good specialists if you contact us.

 

For more information visit the HMRC website http://www.hmrc.gov.uk/consultations/ir35forum-home.htm

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