February 06, 2013

An Idiot’s Guide: IR35

In 1999, the Inland Revenue issued a press release to outline that they had ‘closed a loophole’ that previously allowed freelancers and contractors to avoid paying the majority of their tax and national insurance.

IR35 is the UK tax legislation designed to make sure freelancers whose relationship with their employer is such that if they had been paid directly would:

• 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.

Staff on their company’s payroll are ordered to pay up to 50% of their salaries in income tax, while they and their employers must also contribute to National Insurance. By contrast, freelancers paid through “personal service companies” pay corporation tax at 21%, and are exempt from NI contributions.

Crack Down

In the last 12 months, the number of HMRC inquiries have doubled, and HMRC themselves have begun to delegate specialists to tackle ‘disguised employees’.  The UK’s tax yield from IR35 enquiries increased dramatically from £219,180 in 2010/11 to £1.25 million in 2011/12.

Some of the aspects that HMRC may investigate to check whether a person is liable to be in breach of IR35 are:

1. Financial Risk: Contractors are open to financial risk, so to be outside of IR35, a person should be able to prove that they’re at financial risk. For example, that there’s a chance a client may fail to pay on time, or pay at all!

2. Company Benefits: They should not be entitled to company benefits such as holiday pay, pension contributions, sick pay, or training courses.

3. Control: They should be able to demonstrate that they are in charge of their own work schedule.

4. Company equipment: They should be using their own equipment, rather than the company’s they’re working for (although this is not a definitive)

5. Performing Your Task: There should be a clause in the contract that ensures no one else is allowed to perform the role that you’ve been hired to undertake as a freelancer.

6. Dismissal period: contractors tend to have immediate terminations written into their contracts, rather than notice periods, which is characteristic of employees.

However, methods of investigation have come under fire as a result of their susceptibility to differing interpretation. Critics of the legislation lament the criteria’s subjective nature, arguing that decisions can be skewed depending on personal perception.

Furthermore, IR35 also relies heavily on self-certification by contractors. The obvious flaw of this is that not all contractors will be so eager to voluntarily sacrifice up to 25% of their income in order to comply.

This article was written by Laura Moulden on behalf of Nixon Williams, a firm of contractor accountants offering comprehensive accountancy services for IT contractors.

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