Responsibilities to HMRC and Companies House

Limited company IR35 rules – what is IR35?

IR35 legislation, sometimes called “intermediary legislation” or “off-payroll working legislation”, is a series of tests that HMRC applies to the nature of the working relationship between a client and a contractor using a limited company (sometimes called a personal service company).

There is no IR35 for dummies – it’s a complicated set of rules open to interpretation. It’s so complicated that even HMRC often get the interpretation of the rules wrong. In fact HMRC lose many of the cases they bring to the First Tier Tax Tribunal against contractors.

Historically contractors working through a limited company have paid considerably less tax than an employee doing the same type of work. The contractor isn’t the only one that gets a tax benefit by engaging a contractor. Because the contractor isn’t an employee, a client also does not have to pay National Insurance Employers’ Contributions on their fee.

With less tax being paid, the UK government sought to introduce IR35 as a way to get those tax revenues back. In essence, the legislation was designed to look at a contractors working practices and ensure that if they acted like an employee then they processed their payroll like an employee too, locking themselves out of the tax benefits they would have traditionally enjoyed.

Now that you know what IR35 is, you might be wondering what ‘’inside IR35’’ means (for public and private sectors). If the relationship between a contractor and a client is like that of an employer and employee in under the IR35 test, this would constitute a “contract inside IR35” arrangement.

In this case, a contractor must treat their entire payment in the Ltd Co as a “deemed salary” – in other words, they would have to pay taxes as if they were an employee on the full amount and not offset expenses or take dividends.

A “contract outside IR35” is a contract with a client which the IR35 rules deems is not similar to an employee-employer relationship. In this instance, the client would pay the value of the invoices issued into the contractor limited company’s account without any deduction for tax. Corporation tax would be paid on the work if the limited company made a profit during the year. The company would then process the salary (often small) through PAYE and pay any taxes due to HRMC directly with the remainder of the funds paid in dividends. The contractor would then pay personal taxes on any dividends withdrawn from the company, summarising the tax due on their self-assessment at the end of the year.

A contractor has a legal responsibility to declare whether the agreement they are working under is inside or outside of the IR35 rules, record it in the appropriate way, and pay the relevant tax.

When does IR35 apply?

IR35 applies when some or all of the above conditions apply to the working arrangements between a client and a contractor. Regardless of the governing contract, this situation would be in the scope of IR35. However, if there is sufficient independence as measured by these guidelines, the contract would be outside of IR35.

An “outside IR35” arrangement offers zero hours contract holiday pay and zero hours contract sick pay – in other words, if a contractor does not turn up for work, they won’t be paid.

Who decides IR35 status in the public sector and private sectors?

For contracts carried out for public sector bodies, the responsibility lies with the client to declare IR35 status and not with the contractor. Until April 2020, when the same rule comes in for contracts carried out for medium- and large-sized businesses, the responsibility to accurately declare IR35 is that of the contractor.

The IR35 status tests

For a contract with a client to be considered outside of IR35, the nature of the actual working relationship has to be more like two independent businesses dealing with each other rather than an employer-employee set up. Whereas once contractors pointed to the letter of their contract when arguing their case for being outside of IR35, HMRC will now primarily consider the actual working environment a contractor finds themselves in when deciding on IR35 status.

How to avoid IR35

A contractor should make sure that their working arrangements with their client (codified in their agreement) has most or all of the following features, but also that in practice these are maintained too:

• A client does not tell a contractor where or when they will work
• A client cannot object to a contractor sending in someone else to do the work and a client recognises that a contractor has the legal right to do so
• A contractor will work without direction and with minimal oversight from a client
• A contractor can refuse to perform a task not contained in the agreement
• A contractor can raise an invoice to perform a task not contained in the agreement
• A client can not object to a contractor taking a holiday nor can they dictate when this will happen
• A contractor is responsible for reimbursing a client or putting right a situation if caused by the quality or efficacy of a contractor’s work
• A contractor can choose what tools and equipment are needed to perform a task and it is the contractor who supplies them
• A contractor can end their agreement early with 30 days’ notice
• A contractor has no power to direct, discipline, appraise, manage, or supervise the client’s employees

How does IR35 affect contractor take home pay?

At time of writing, new tax laws for contractors mean that the difference in pay between a limited company contractor working outside IR35 and inside IR35 is significant.

A Director’s roles and the Companies Act 2006

Directors of contractor limited companies have certain fiduciary and statutory duties to perform. Failure to perform them correctly leaves a director open to financial, legal, and personal risk.

To fulfil their fiduciary duties, a director must act in good faith and with honesty. They must do what is in the best interests of the company and for the benefit of the company.

For their statutory duties, they must exercise reasonable skills, independent judgement, diligence, and care in their role. They must act within the powers given to them by the Companies Act 2006 and by the company’s Articles. They must avoid conflicts of interest, not accept benefits from third parties which benefit them as opposed to the company, and do everything to promote the success of the company.

To help directors understand their duties, Companies House have produced the following guides – GP2 and GP3.

What is a confirmation statement?

Every twelve months, a contractor limited company director must file a confirmation statement with Companies House detailing the company’s registered office, their shareholders, their line of business, the amount of share capital that’s been issued, who owns the shares in the business, and the Persons of Significant Control.

A Person of Significant Control (PSC) is a person who owns a quarter or more of the shares and the voting rights. A PSC can appoint or remove the majority of a company’s directors or, in some way, “exercise significant influence or control”.

Keeping HMRC up to date with staffing records

Any contractor limited company wishing to recruit staff must register first with HMRC. Even if the only person working for a company is the director, the company will still need to register. Within 5 days of application, HMRC will send out a company’s PAYE reference number.

A director or someone with responsibility for payroll must inform HMRC of any new staff member who will need to be paid through PAYE. They will also need to tell HMRC when an employee has left.

PAYE collection, reporting, and submission (including RTI)

Employers are legally obliged to withhold the correct amount income tax and employee’s National Insurance every time they pay a member of staff. They must also inform HRMC that payment has been made via the RTI system (all recent payroll software is RTI compliant).

In addition, if a staff member earns over a certain amount (detailed on this page), 13.8% of that staff members’ wage must be paid in Employer National Insurance. That means that, if a staff member earns £2,000 before tax each month, 13.8% of that £2,000 must be paid on top in Employer National Insurance.

A contractor limited company must hold this money until the 22^ndof the following month on which date it must transfer all withheld income tax, Employee National Insurance, and Employer National Insurance to HMRC.

Contractor VAT – when and how to register

When a business has turned over (or it appears that it will turn over) £85,000 or more in a single year, it must register with HMRC for VAT.

This means that the company now must charge VAT on top of all of its invoices at the applicable rate. An agent can register a contractor limited company for VAT on its behalf or a director of the company can do this themselves by clicking here.

To work out how much VAT is due to HMRC (or vice versa), a company must calculate the value of all the VAT is has charged during the VAT period. This is output VAT. It must then calculate the value of VAT it has paid its suppliers during the same period. This is input VAT. Input VAT is then subtracted from output VAT to determine the amount that must be paid to (or from) HMRC.

Contractor limited companies can choose whether to account for VAT on an accruals basis (when an invoice is issued) or a cash basis (when an invoice is paid) if its turnover is less than £1.35m per annum.

A company may choose to register for VAT if it is not at the threshold to claim its input VAT back.

Contractor VAT – what is Flat Rate VAT?

For contractor limited companies with a turnover of less than £150,000, the VAT flat rate scheme offers a simplified version of accounting for and paying VAT. Invoices are still issued with VAT but, instead of working out input and output VAT, a flat rate percentage of the VAT-inclusive value of an invoice is withheld instead for later payment.

For example, an IT contractor limited company has a flat VAT rate of 14.5%. On an invoice of £1,000 plus VAT totalling £1,200, 14.5% of £1,200 would be held back for payment.

Flat rate VAT contractors can claim input VAT on business purchases of £2,000 including VAT. There is a discount of 1% of the standard flat VAT rate during a contractor limited company’s first year of registration.

If a contracting limited company spends less than 2% of their VAT-inclusive turnover on allowable suppliers (or less than £1,000 if greater than 2% of turnover), the flat rate VAT is 16.5%.

VAT reporting and payment submission

In the vast majority of cases, VAT is payable every quarter. At the end of a quarter, a business has one month and seven days in which to submit their return and make payment in full.

From April 2019, Making Tax Digital replaces the current system. Making Tax Digital requires VAT-registered businesses to keep far more detailed digital records of their VAT transactions. Most online bookkeeping packages are currently being updated to be compatible with the new system.