IR35 is a term heard frequently within the world of contracting and freelancing, and is a very important and often vital concept to any self-employed professional operating their own limited company or partnership.
What is IR35?
IR35 is the name given to a tax legislation introduced by HMRC regarding the validity of contractors within the professional working realm. The IR35 rules originated back in 1999 and were bought in in 2000 as a way to ensure that individuals working as contractors were not actually employees posing as independent entities to avoid paying full employment tax.
IR35 Rules Explained
Contractors working via limited companies are not liable to pay national insurance (NICs) on income taken as dividends, resulting technically in a revenue loss to the Treasury.
The HMRC states that, ‘The aim of the legislation is to eliminate the avoidance of tax and National Insurance Contributions (NICs) through the use of intermediaries, such as Personal Service Companies or partnerships, in circumstances where an individual worker would otherwise -
- For tax purposes, be regarded as an employee of the client; and
- For NICs purposes, be regarded as employed in employed earner’s employment by the client.’
The concept of employees posing as contractors in order to avoid certain tax brackets was described by the HMRC as a ‘disguised employee’, and this is what the entire IR35 legislation is based on.
The current IR35 rules have been undergoing changes since July 2010, when the office of ‘Tax Simplification’ came into play as an attempt to ensure small businesses with a simplified system of tax, and since then HMRC has been tightening their grip on anyone found to potentially be classed as a ‘disguised employee’.
Of course, thousands of ‘one man band’ contractors will legitimately be operating through limited companies, but the IR35 rules are complex and it’s vital that all freelancers are fully aware of them.
Contractors can be subject to an IR35 enquiry, where HMRC look at their contracts and arrangements in depth. If they subsequently decide that the contractor is ‘inside IR35’, and therefore a ‘disguised employee’, they will demand all backdated tax and national insurance, plus interest and a possible penalty. The amounts involved can be financially crippling to contractors.
*Key Point* Professionals who work as contractors pay far less tax than an average employee, significantly increasing their take home pay. This highlights the importance of the HMRC tracking down and scrutinising potential ‘disguised employees’.