A Guide to IR35 Contracting Rules

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Since their introduction in 1999, IR35 contract rules have caused quite the stir among the self-employed contracting community. They were originally intended as a method of clamping down on employees in all but name who set up a limited company to circumvent tax rules and pay a reduced rate. However, IR35 has since evolved into a dragnet into which HMRC can sweep virtually all self-employed contractors and force them to pay a higher rate of tax…

This evolution of IR35 over time has not gone unnoticed by those who have seen their income significantly diminished by HMRC repeatedly moving the goalposts, and the scheme has come under consistent criticism by experts in the industry and contractors alike.

In a bid to make the process more transparent and assuage concerns, HMRC introduced its Check Employment Status for Tax tool (CEST) in 2017, though subsequent controversies surrounding the tool have also rendered it liable to reproach.

As such, can be difficult for self-employed contractors to understand fully the rules surrounding IR35 contracts and whether they themselves are deemed to be “inside IR35”. With that in mind, this handy guide aims to provide a short rundown of the exact regulations, as well as providing advice to those who aren’t certain of how to ensure they maximise their earnings without falling foul of the law.

A short history of IR35

IR35 contract rules were initially introduced just before the turn of the millennium to tackle the rise of people using intermediary limited companies in order to pay a lower rate of tax, while still operating by-and-large as an employee of their end client. Since the client would no longer have to pay national insurance contributions for a contractor, and the contractor themselves could take advantage of the dividends and lower rate of corporate tax afforded to limited companies, it was a win-win arrangement for all involved – except the government.

Aware of the fact that it was missing out on potentially millions of pounds in tax revenue, HMRC introduced IR35 in 1999, which penalised those serving as an employee in all but name. Those found to be manipulating the system were forced to submit to PAYE tax rates, but over the years, the scheme has evolved into something more geared towards maximising the amount of tax paid by legitimate self-employed people, as well.

As of April 2017, HMRC amended the rules surrounding IR35 in the public sector so that the end client was now responsible for determining whether the contractor fell within IR35 contract rules. Wary of penalisation, many of these clients simply blanketed all of their partners as being “inside IR35” or, worse still, ceased trading with them altogether. This meant that thousands of contractors across Britain were left out of pocket. With the rule due to expand to include the private sector in April 2020, the regulations are set to affect countless more people, too.

Implications for self-employed contractors

The impact of these rules has already been felt across the public sector. HMRC stipulates that it judges an individual to be an employee rather than a contractor (and therefore working within an IR35 contract) on the basis of three grounds:

a) control (the amount of control they exert over how, when and where they work

b) substitution (whether they can send a substitute in their place)

c) mutuality of obligation (whether work must be found by the client and accepted by the contractor as part of their arrangement).

From 2020 onwards, self-employed contractors of all stripes will face the very real possibility that HMRC will view IR35 as applicable to their situation. In real terms, this means like contractors are likely to be subject to a 25% increase in the amount of tax they pay, since they will no longer be able to capitalise on lower tax rates and dividend rules contained within the setting up of a limited company.

In this sense, the financial benefits of self-employment will be largely negated, while the risks associated with it will remain. Self-employed individuals have little job security, no pension, no holiday pay, no sick pay and no maternity or paternity leave. It was in recognition of these drawbacks that contractors were encouraged to take advantage of the same breaks afforded to corporate entities through setting up a limited company, as well as serving as an incentive for investing their profits back into the national economy.

Taking shelter under an umbrella

With HMRC taking strides to eliminate most of the financial benefits associated with setting up a limited company and working as a self-employed contractor, one possible solution to the problem could be to contract the services of an umbrella company. These firms “hire” contractors to their payroll and treat them as an employee, bypassing the need for IR35 altogether.

As well as sidestepping all of the stress and anxieties associated with trying to work out whether or not your working relationships are deemed as IR35 contracts or not, umbrella companies also offer plenty of other benefits, too. They can handle all of your invoicing, expenses and tax returns for starters, taking a huge burden off your mind. What’s more, as an “employee”, you’ll receive the same statutory benefits outlined above as the rest of the national workforce does.

In exchange for these services, umbrella companies charge a regular fee (normally payable weekly or monthly). Of course, not all umbrella companies are created equal. Some charge higher rates for more comprehensive packages, some offer discounted fees for a more threadbare service, and some fall somewhere in between the two extremes.

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