Is It Better to Be Inside or Outside IR35 from April 2020?

What is IR35?

It’s important to have a full understanding of what IR35 entails before you know how it is changing. In the simplest form, IR35, which is also known as ‘intermediaries legislation’, is a series of tax laws that came into effect in 2000 and have been revised over subsequent years. Its purpose was at first to ensure that contractors who stated that they owned limited companies were genuinely self-employed, but over time it has evolved into a set of rules designed to curb the tax benefits self-employed workers altogether.

Working through a Limited Company has always been more tax efficient than being an employee because the government wanted to financially reward those enterprising enough to go it alone and invest in the economy (with the hope of making money and creating jobs). The problem for the government was that Limited Companies were meant to be for people who bought and sold goods or services to multiple clients, not necessarily contractors who didn’t need to invest large sums of capital to start a business and acted like an employee.

In 2000 this presented a real fiscal problem for the government, who found a number of employees had chosen to leave their employed roles only to return to work as a contractor. The sole purpose of this change was to reduce the amount of tax they paid. The government therefore designed IR35 to make sure this could not continue. However, for all its good intentions in 2000, IR35 has been subject to several changes since it was first put in place, and April 2020 it will see even more changes designed to increase tax revenues.

These changes haven’t been without controversy. Many contractors who legitimately work short term contracts, moving from company to company to offer their specialist services have now been caught by IR35 and lost their tax benefits as a result.

Changes to IR35

IR35 has existed since 2000 and has been subjected to different amendments over time. Despite these changes, it has been criticised as not being effective enough by some while others claim it goes too far.

The government believes that too many people are still illegitimately working as ‘disguised employees’ and claim that they are self-employed for the tax benefits. This means that they operate like a standard employee, without control over how and when they work, what work they do and other factors.

According to HMRC, working in this way means that they are not ‘a business in their own account.’ As many contractors work side by side with employees, this interpretation of running a business has in turn been criticized, with many contractors feeling like because they are a micro-business with just one employee they are seen as an easy target for the government to raise tax revenue from.

For the most part from 2000 to 2017, in order to be classed as “outside” of IR35, contractors would need to jump through a number of vague hoops. These included things like:

1. Writing the right to substitution into their contract (even though in practice it was unlikely they would send an employee to do the work).
2. Not being managed by their client, and working to their own working schedule/holidays.
3. Having their own office and web presence.

Those that turned up to work wearing an employee uniform, worked organized shift patterns, and were managed by the client, would have been classed as “inside” IR35 and had to pay their taxes as if they were employed but as there was no real implication for the end client many didn’t.

After years of vague IR35 rules, in 2017 the government sought to revolutionise how IR35 was classified, introducing the new new ‘off-payroll’ rules. These rules applied to those working in the public sector only and were seen as the first step in an eventual plan to tackle the contracting community as a whole.

The new rules meant that contractors were no longer responsible for determining their IR35 status. Instead, the client who the workers were providing their services to were responsible with hefty fines for them if they got it wrong.

As a result, most public sector clients chose to classify all of their contractors as “inside” IR35 rather than run the risk of a penalty. This prompted widespread confusion and anger amongst the contractor community who saw their tax position change regardless of the reality of their situation.

What is happening in April 2020?

The IR35 rules will be changing again in April 2020 to replicate the changes made to the public sector classification of contractors into the private sector. It is widely expected that the public sector will react by:

1. No longer using contractors.
2. Classifying all contractors inside IR35.

However, there are exceptions for contractors working with small clients.

If a client is classed as a small organisation in the eyes of the government then the new legislation will not apply. A client’s size is determined by several factors which are outlined in the Companies Act 2006.

These factors are:

• Having an annual turnover less than £10.2 million
• Company balance sheet total must not be more than £5.1 million
• The number of company employees must be less than 50

What does it mean to ‘be inside’ IR35?

To ‘be inside’ IR35 means that for the purposes of tax, you are classed as an employee of your client regardless of whether you’re self-employed or not.

Under IR35 you will be subject to PAYE (pay as you earn) tax rules and all the income you earn (less your accountancy cost) will need to be processed through PAYE as a salary from your Limited Company. This means you can’t use the dividend or expenses mechanisms and therefore won’t get a tax benefit from using your own company (despite the extra hassle).

According to current legislation, responsibility for calculating and paying tax has changed hands. Public sector clients are responsible for paying all tax instead of the contractor who is working for them. For this reason public sector clients will either deduct your tax before they make payment to you or ask for proof that you are paying the correct amount of tax instead.

If you’re deemed to be “inside” IR35 but do not adhere to these rules, both you and your client can face hefty repayments, interest and fines.

It’s also worth noting that HRMC can challenge the clients determination of your IR35 status, so if they find you “outside” of IR35 but HMRC feels you are “inside”, you may still find that you are caught.

What does it mean to ‘be outside’ IR35?

To ‘be outside’ of IR35 is also called being ‘IR35 compliant.’

These are terms that are sometimes used in marketing by umbrella companies. They show that they operate within the rules of IR35 when dealing with contractors. However, IR35 doesn’t actually apply to them, so it’s a bit misleading to use it as a selling point.

People who HMRC/the client deems to ‘be outside’ of IR35 are genuine contractors or owners of limited companies. They are allowed to sue the dividend and expenses mechanism and as such enjoy lower taxes.

If you’re deems as “inside” IR35, then using a Ltd Co is virtually pointless, so many contractors will therefore use an Umbrella Company to process their payroll in order to get the maximum take home with the minimum hassle.

Umbrellas are often cheaper than accountants and come with a number of benefits including statutory benefits.

This is because in order to process your payroll, the umbrella will actually employ you (you can’t be a disguised employee if you’re employed) and thus process you through their company payroll.

In return you also therefore get access to their insurance cover and any benefits they may offer (much like a normal employee) like a pension.

Which is best for April 2020?

Right now compared to being “inside” IR35 there are significant benefits to being found “outside” of IR35.

Currently, if you work inside IR35, HMRC entitles you to a 5% expenses allowance which must include your accountancy fees. In reality there is no real tax advantage for those caught by IR35 and you must weigh up whether the hassle of doing your own accounts, invoicing and debt collecting is worth that 5%.

For those found to be “outside” of IR35 there are still real tax benefits to be enjoyed. However this is likely to change from 2020 where it will be much harder to be deemed “outside” of IR35.

In fact being deemed “outside” will probably become a selling point of some clients over others when IR35 changes hit the private sector as the resulting tax advantage might be a deal closer.

How an umbrella company can help

With constant changes and uncertainty, IR35 is far from simple. If you want to avoid it altogether, umbrella companies offer a convenient solution. By classing you as an employee for tax purposes and deducting your tax contributions, they allow you to merge the benefits of contracting with the security of employment. Best of all you can’t fall ofuld of IR35 by using an umbrella company.

Want to get rid of all the hassle? Use our online umbrella comparison tool to find the best umbrella company for you.