A Guide to IR35 for IT Contractors

IR35 has had a massive impact on contractors and how they work. That’s no exception for IT contractors, who make up a large proportion of the self-employed market. In this post, we’ll take a closer look at the ins and outs of IR35 for IT contractors and the effects it’s had upon them.

What is IR35 for IT contractors?

First introduced in 2000, IR35 is a series of subsequent ax laws (rolled out over a number of years) that were enacted through the annual Financial Acts. The UK government uses IR35 as a way to make sure that IT contractors and others pay the correct income tax and national insurance tax. In essence IR35 is a tool which allows HMRC to treat you for tax purposes as an employee of your end client rather than a sole-trader or the owner of a limited company.

While HMRC can’t class every IT contractor as an employee of their end client. IR35 allows them to look for two main indicators when deciding how a contractor should be treated tax wise.

The first is very clear cut; since 2017 any IT contractor working for a public sector end client has generally been considered inside IR35 (although this isn’t the case 100% of the time).

The second is less clear; do you act as an IT contractor or an employee?

Employees wouldn’t have the freedom to choose how, when or where they worked – the same as employees. They might not be able to turn down work given to them, in the same way that an employee cannot refuse to do work. If you removed the intermediary (their limited company) from the process, they would be an employee in all but name (referred to as a disguised employee).

Working through a limited company, these ‘disguised employees’ would be entitled to lower taxation through dividends and corporation tax, and thus short change HMRC of tax revenue.

On the other hand, legitimate self-employed workers can choose their working style, accept or refuse work, pick their own workplace or outfit and only have to work on a project-to-project basis.

While the number of IT contractors acting as disguised employees was actually very small, by the fact of being a contractor they were swept up in IR35. Over time as IT contractors adapted their working practices and contracts to abide by the rules, IR35 has been repeatedly adapted.

Controversially what started as a set of rules to catch small time low paid workers turning to contracting to save tax turned into a full scale assault on legitimate contractors and their tax affairs (as HMRC realized the tax revenues it could generate as a result of targeting high earning workers like IT contractors).

The rules of IR35 will be changing again in April 2020 to automatically catch all private sector IT contractors.

How did IR35 affect the public sector?

One of the most controversial changes to the rules of IR35 happened in 2017. In April that year, new ‘off-payroll’ rules came into effect. Before these rules it was down to the contractor to prove that they were genuinely self-employed. This is called being ‘outside IR35,’ and means that you are correctly paying the lower taxes reserved for entrepreneurial workers. The alternative is referred to as being ‘inside IR35,’ which is the same as being a disguised employee.

As of 2017 it was no longer a public sector IT contractors responsibility to decide if they were caught by IR35. The public sector end client that you worked for had to prove to HMRC that you were a legitimate contractor with financial penalties if they got it wrong. Naturally under the threat of financial losses most departments simply blanket classed their contractors as inside IR35.

A knock-on effect

The 2017 rules meant that public sector companies and contractors could no longer use these tactics to save on tax. Contractors who were caught out by HMRC could face fines and have to pay back the tax owed and interest. Companies could also be asked to pay back the money that should have been taken at source. Both parties could also face fines for late payments.

These changes to IR35 only applied to contractors working in the public sector. As a result, some public sector companies stopped using contractors inside IR35. The companies did not want the responsibility of proving that the contractors were legitimate. This meant that some contractors lost out on work, and the new rules were heavily criticized.

As many public sector companies refused to use contractors for projects like crucial IT projects, workers were forced to look to the private sector with many government sponsored projects getting a lower quality of project as a result.

How is IR35 changing?

In April 2020, the rules of IR35 are planned to change again despite facing more criticism. These new amendments mean that the change in responsibility of proof will now apply to companies in the private sector as well.

Contractors who thought that working in the private sector would be the solution will have to deal with this issue next year. Like public sector companies, those in the private sector will have to make sure that their workers are legitimate, so they are not fined.

It is widely expected that private sector companies will follow their public sector counter parts and either stop using contractors or declare them inside of IR35.

How could it affect IT contractors?

When IT contractors were turned away by public sector companies in 2017, many found work in the private sector. They lost out on public sector opportunities like working for the NHS and MOD, who no longer wanted the risk of using contractors. Projects like the HS2 also turned them down. Despite private sector companies still being an option, this also had its problems.

The uncertainty of Brexit meant that millions of companies have put billions of pounds of technology and IT projects on hold. As we do not know what the effects of Brexit will be on the UK, there is uncertainty about the future of these projects. This lack of insight means that there may be less opportunities for IT contractors.

However, there is some good news. Many private sector businesses still have an urgent need for IT contractors. There are still many projects that must go ahead. Being skilled in areas of IT such as programming or software engineering is highly sought after. The contractors that do work in the private sector can charge high rates for their services, knowing that their knowledge is valuable.

How to sidestep IR35

Despite IR35 and its many changes causing confusion for contractors and companies, there is an easy solution. Working for an umbrella company means that contractors do not have to worry about IR35. In the eyes of the umbrella company and HMRC, they are employees anyway. Umbrella companies calculate and deduct the correct taxes at source. So, there’s no need to deal with IR35 and it’s implication on a Limited Company.

At Umbrella Supermarket, we make it easy to find the perfect umbrella company for you. Alongside our invaluable resources, you can compare umbrella companies to find the best deal from leading providers and take the hassle out of self-employment.

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