For anyone who works as a self-employed contractor, or is thinking of doing so, getting familiar with IR35 is incredibly important. IR35 refers to a specific portion of legislation within the Finance Act 2000. It was created in order to enable genuine contractors to be distinguished from those simply trying to dodge the taxman. Here is an overview of this essential legislation, and how to stay on the right side of it and keep the taxman happy.
Employees in Disguise
Tax evasion is a problem that is evident across nearly all industries, and can lead to serious consequences for those who choose to break the law. However, there is a large grey area where the actions may not be actually illegal but certainly not in keeping with the spirit of the legislation.
One of the ways in which some try to avoid paying tax is by becoming “disguised employees”. For example, an ICT administrator could leave their full-time position with a given company, only to return soon after as an independent contractor, fulfilling much the same role as they did before in an effort to avoid paying proper taxes. Those claiming to be self-employed and working through an intermediary limited company manage to avoid paying the tax and Class 1 National Insurance contributions that their co-workers are subject to. IR35 applies to those who claim to be contractors, when their “client” is actually their employer.
Those who operate through an intermediary limited company as a “disguised employee” are able to unfairly reap the benefits of self-employment. Such benefits include the ability to take company profits whilst only having to pay corporation tax. IR35 helps to ensure that this practice is identified and prevented, making “disguised employees” receive payment on a PAYE (pay as you earn) basis, like their employed colleagues. Failing to comply with the IR35 legislation could lead to severe penalties from HMRC for both the contractor and the client in question. By enforcing the PAYE system, all employees pay Class 1 National Insurance contributions and tax, keeping things fair for everyone.
As previously mentioned, one of the main purposes of IR35 is to help distinguish between genuine contractors and those simply trying to avoid paying tax. For those who are legitimate contractors, getting to grips with IR35 is crucial in order to stay in the “good books” of HMRC. Self-employed contractors need to thoroughly check their contract to prevent them falling foul of IR35 and being classed as “disguised contractors”. It can be quite a complex concept to tackle, though you can find out more about IR35 from Brookson - a specialist accountancy for contractors.
The agreement between the contractor and client needs to be one for services and not of services. Contracts of service are essentially identical to those held between an employer and employee, meaning that they need to pay tax accordingly. By maintaining a proper contract for service, self-employed contractors need not worry about coming under fire from the taxman. By properly understanding the implications of IR35, contractors can have peace of mind that they won't be penalised from HMRC.
IR35 was put in place to ensure that those trying to operate through intermediary limited companies as a method to avoid paying tax are identified. With the IR35 portion of the Finance Act 2000, genuine contractors can be easily distinguished from “disguised employees”. By making sure that contracts do not fall into IR35, self-employed workers can be safe in the knowledge that they are operating within the law.