HMRC’s drive to combat tax collection gap and tax avoidance in recent years has extended to contractors working in the private sector contractors who, in the eyes of the tax authorities, are deemed to be a ‘disguised employee.’
The Intermediaries Legislation 35 (IR35) will come into force in the private sector from April 2020 and is designed to identify individuals that are registered as ‘self-employed’ but should technically be classed as an employee. Contractors and employed workers are taxed in different ways. Self-employed workers pay less National Insurance contributions and are given more tax allowances.
In a nutshell, IR35 says if your working arrangement is akin to an employee, you should be taxed as an employee. The legislation covers a wide range of contractors in the private sector including IT, construction, energy, creative media, engineering, rail, construction, recruitment, management, consultancy, and health.
Businesses that use freelancers and contractors also need to be assured you are adhering to the new tax rules. Individuals hired for one-off projects that are not classed as employees are not entitled to company benefits such as NI contributions and sick pay.
Inside or Outside IR35
HMRC determine whether individuals are employers or contractors in relation to three principles that determine the employment status of individuals.
It is deemed that individuals with contracts that fall inside IR35 are taxed as an employee. Contractors working outside IR35 are permitted to take a salary and dividends from the company.
The three principles are as follows
Control – an assessment of how much supervision, director and control a client has over where you work, how you perform your work and when the project is due to be completed
Substitution – if the contracted person can send someone else to do the job, they are classed as a contractor. In situations where they are deemed to be providing a ‘personal service,’ HMRC can deem you to be an employee.
Mutuality of Obligation – this is where there is an obligation for a company to provide work and a contractor to accept it. If companies and contractors have the choice of who they want to work with, there is no mutual obligation.
How to Prepare for IR35
Contractors that intend to work outside IR35 and take a salary and dividends from your company should take steps to ensure you pass an IR35 enquiry.
In cases where HMRC determine contracts are ‘disguised employees’, you will be ordered to pay increased taxes and NI contributions including back pay, interest and a penalty.
An investigation that goes against you could end up costing you thousands of pounds, so don’t run the risk of assuming you will pass an IR35 test. In order to prepare for IR35, take the following steps.
- Take the IR35 Test Beforehand
You can determine whether you are likely to fall inside or outside the IR35 protocol by taking a test before HMRC investigate your status. You can take the test on HMRC’s website here.
- Update Contract Agreement
HMRC use specific criteria to qualify whether a contractual arrangement determines whether an individual is an employee or a contractor.
Freelancers and businesses that intend to work outside IR35 should draft contracts that reflect your role as a self-employed contractor rather than an employee.
The type of information to include in a contract of agreement should include, the location where the work is carried out, how you will be paid, the ability to work with other clients, that you use your own equipment, and a non-entitlement to benefits in kind.
It is advisable to consult with Tax Accountants for Contractors to ensure any changes you make to existing contracts are not deemed to be for the purpose of evading tax.
- Join an Umbrella Company
Contractors in the public sector joined an Umbrella Company to get around IR35 rules. This is also a good option if you want to avoid the hassle of running your business as a limited company.
There are, however, advantages and disadvantages with this option.
Essentially you become an employee of the agency and whilst you escape having to complete VAT returns and other company accounts involved in the taxation process, you will have to pay admin fees for the agency to do this for you.
Other fees will also be involved such as marketing and VAT. Check out the costs involved before signing up to an Umbrella Company.
IR35 legislation can be complicated for contractors. If you are unsure whether you fall inside or outside IR35, contact one of our advisors for assistance.
- IR35 Appeals
If you are a contractor working in private sector or a locum doctor who is subject to IR35 rules, call us today to discuss your arrangements with employers. We specialize in filling appeals and our success rate is more than 90%.