Established in 1999, IR35 is tax legislation there to prevent individuals from avoiding paying tax by supplying their products and/or services through an intermediary – such as a limited company.
Inside IR35 means
Inside IR35 is HMRC’s term for individuals registered as limited companies who behave like employees are in violation of this regulation.
Outside IR35 means
Businesses that don’t violate IR35 are considered ‘outside IR35’ which means that they won’t face any penalties or additional fees.
How status is determined
Since April 2020, every medium and large company is responsible for setting their contractor’s tax status. HMRC are able to examine the tax status of the contractors at any time and when evaluating if an individual is inside or outside HMRC they will disregard any written contract and instead consider the business’s relationship to the contractor. Contact an accountant like Fortress Accounts if your need support.
HMRC will consider the following factors:
- Control – The amount of power the business has over the contractor’s assignments.
- Substitution – Is the assignment or assignments person-specific or can someone else complete them apart from the contractor.
- Mutuality of obligation – If the company is obligated to provide work to the contractor and must the contractor accept it
Other considerations by HMRC include the type of contract, the contractor’s role in the organisation, the financial risks for the contractor, and if the company provides the required equipment.
Why the crack-down?
It’s been just over two decades since IR35 was introduced and up until the last 2 years, it was mostly ignored, with contractors themselves choosing if it applied to them or not and charging accordingly. The issue was that the majority of contractors were deciding that they belonged outside IR35, which meant they were reaping the financial benefits of full-time employment but not paying any taxes – which HMRC has estimated was a government loss of £1.3 billion per year.
The impact IR35 could have on your business
If assessed as inside IR35, contractors will be required to pay the same amount of NICs and income tax as if they were employed. They will also still not be eligible for the employment benefits such as holiday or sick pay. This can have a serious impact on a contractor’s finances and reduce their net income by up to 25%. What’s more is that HMRC can go back a minimum of 6 years to evaluate all contracts within this time frame and see if the legislation applied, which could result in contractors owing hundreds of thousands of pounds to HMRC. Private companies can face similar charges.
A lot of contractors are now beginning to look for permanent employment because of the IR35 crackdown. This means that businesses may find it more difficult to recruit contractors and so will have to finance the employment regulations of in-house employees. Previously it was more appealing to many contractors to waver employment rights in favour of higher salaries but with IR35 diminishing contractors earning potential this form of employment is rapidly losing its appeal. Industries such as IT and media may be more affected as they have a greater need for long-term contractors. With them starting to be in shorter supply, a diminished pool of suitable applicants could lead to a skills shortage and businesses having to find alternate ways to attract contractors.