If you’ve ever been a contractor or hired a contractor using a Limited Company (sole traders needn’t worry… yet), chances are the word ‘IR35’ brings you a great deal of confusion and stress.
Whilst it’s a welcome relief for many that the IR35 reforms have been delayed until April 2021, this doesn’t mean it’s gone away altogether.
Here’s our overview of the IR35 situation.
It’s complicated. It affects many thousands of self-employed people here in the UK. The consequences of putting a foot wrong are high, as the government is seeking to clamp down on tax avoidance in this area. What’s more, it’s a (slowly) shifting landscape.
So we wanted to take the time to explain everything you need to know. (Keep in mind that when we talk about the changes coming into effect, we’re talking about April 2021. You’ve got a good long while to prepare!)
In this article, you’ll find:
IR35 is a set of tax laws that were introduced by Gordon Brown in 2000. (The ‘IR’ stands for Inland Revenue, the old name for HMRC.)
The legislation was designed to close a loophole in the tax system that meant workers could use a Limited Company setup to pay less tax.
It looks at the reality of your working relationship with your client. Are you genuinely behaving like an external service provider, or do you actually have more of an employer<>employee relationship with your client?
The latter would make you a ‘deemed employee’ or ‘disguised employee’. And in the eyes of the legal eagles, that is not a good thing.
Basically, if you’re behaving like an employee, the government wants you and your client to be taxed as if you were an employee.
The idea that underpins all of this is that employees enjoy benefits that Limited Companies don’t - stability, equipment, sick pay and so on - and should therefore pay more income tax and NICs (National Insurance Contributions). And the employer has to pay more tax on their side too, compared to hiring a contractor.
Whether you’re halfway through an engagement or about to take on a new contract (or any other kind of self-employed assignment), you need to know two things:
(More on both of those points below.)
Currently it’s your responsibility to decide if your Limited Company should fall ‘inside’ or ‘outside’ IR35. In April 2021, the responsibility may switch over to your end client, depending on the size of the company.
An easy starting point is simply to ask how your end client sees their engagement with you (or the agency your end client uses for their contractors, if they use one - in other words, the person or organisation that pays your invoices) and take it from there.
If you’re ‘outside IR35’, happy days, it’s business as usual. But if you’re ‘inside’, you’ll need to make some adjustments.
Worried that you might be under the wrong IR35 determination? We recommend you speak with an accountant to ensure you get the best advice.
If you’re a PSC Limited Company, you’re affected.
Let’s unpack that:
A Limited Company is a business structure where the company has its own legal identity, separate from its shareholders and directors.
PSC stands for Personal Service Company. Put the two together, and the phrase ‘PSC Limited Company’ is used to describe a business that’s owned and operated by a self-employed person who set it up so they can sell their work on as an individual (unlike businesses that manufacture physical goods, for instance).
Freelancers and consultants are often classed as PSC Limited Companies. Even if you don’t personally identify as one, HMRC might still view you as one.
It all comes down to whether you fall inside or outside the IR35 legislation. These are two different IR35 statuses that the government uses to classify workers.
First the good news. If HMRC considers your self-employed engagement as a PSC Limited Company to fall outside of IR35 regulations, it means they’re happy that you’re operating a genuine business and wouldn’t be deemed an employee for tax purposes.
You will be able to pay yourself a salary and draw the remainder of income as dividends from your Limited Company. You remain responsible for paying all your own taxes.
If HMRC considers your engagement to fall inside of IR35, this means you’ll be considered an employee of your end client and should therefore be paying tax as if you were an employee.
Being caught inside of IR35 isn’t necessarily a problem. It just means you’ll need to ensure you are paying the right taxes at the right time.
You also need to make sure you’re 100% clear about the implications on your business finances and your relationship with your client.
If your IR35 status with a current client changes from ‘outside’ to ‘inside’, you have 3 options:
This is definitely a topic to pick up with your accountant.
The short answer is that if you feel like an employee, not an independent service provider, you’re probably inside IR35 and could fall foul of the legislation. No need to panic, but now’s the time to get professional advice and put things right.
Here’s the long answer:
If you work in the public sector, your end client is responsible for determining your IR35 status, so any issues and consequences are mainly theirs to deal with.
But if you work in the private sector, currently you’re the one who’s responsible for determining your IR35 status. (This is due to change in April 2021)
There’s a range of determiners that HMRC use to decide about your IR35 status, and these can also help you figure it out yourself before it gets to that stage. Generally, they cluster around the agreements you have in place with your client and the way your work is actually carried out.
Some of the main ones are:
Check with the professionals around you. Consult with your accountant as they should be highly experienced and knowledgeable around IR35 and all the considerations needed. If you feel like you need further protection there is also tax investigation insurance. This will provide you with the cover and security from an HMRC investigation but do check policy specifics as to what they would cover.
Give the government’s CEST tool a go (Check Employment Status and Tax). This is an online form that will guide you through some questions to help you work out which side of the line you fall.
For self-employed solidarity from other Coconut customers who are facing the same challenges as you, head over to our Coconut Bite forum. And we’ll do our best to answer your questions too.
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As part of HMRC’s Making Tax Digital, sole traders will soon be required to complete 4 tax submissions per year instead of 1.
Take a look at the latest sole trader tax rates for the 2021/22 as well as our advice on how to prepare for the new tax year.