If you’re a contractor, there’s no doubting you’ve heard about IR35. Understanding what it’s all about and how it affects you is a different story.
Are you aware of the impact it can have on take home pay if you are “caught inside IR35”? By understanding how IR35 works from the inside-out, you’ll be able to “stay outside” of the legislation and avoid paying income tax and National Insurance contributions (NIC).
In this article, we’ll help you to develop a better understanding of the legislation and explain how as a contractor, IR35 shouldn’t be swept under the carpet.
As long as you take time to understand how the legislation works and are a genuine contractor, you should have nothing to fear from IR35. Apply best practice to ensure you aren’t caught inside IR35 and prepare with a defence for if you are investigated by HMRC.
What is IR35?
IR35 was introduced by HMRC in 2000 as part of the Finance Act to tackle what they describe as “disguised” employment. But what is disguised employment? This is where individuals try to avoid income tax and National Insurance contributions by falsely claiming to be contractors.
So, IR35 assess whether someone falls into the legislation or not when they take on work for a client. If you fall into the legislation, you are seen as an employee and subsequently have to pay income tax and NIC. Fall outside of the legislation and you are income tax and NIC free.
What falls inside/outside IR35?
To determine whether someone falls inside or outside of IR35, there are some general points to look at.
- Employee benefits - Sick pay, holiday entitlement, pension contributions and other employee benefits fall outside of the legislation as they don’t usually apply to contractors.
- Location and equipment used for a job – If someone works from home using their own computer, they are most likely going to fall outside of IR35 (An employee would be given a computer and desk inside an office to do their job).
- Finances – A contractor (someone more likely to fall outside of IR35) could put their own money into something needed for a job, which is a good indicator they are self-employed. On top of this, they are likely to receive one-off payments when work is completed opposed to a fixed wage at the end of every month.
There are many factors that determine whether you fall inside or outside of IR35. To find out exactly how falling inside or outside of IR35 would affect your income, this calculator is a very helpful tool.
The cost of being caught inside IR35
At this stage, you should be aware that if your contract falls inside IR35, you’ll be paying significantly higher tax and National Insurance Contributions. Unfortunately, resulting in a reduction to overall earnings.
However, workers that are aware their contract is inside IR35 and make the conscious decision to conceal it, aren’t doing themselves any favours. If HMRC find out via an inspection, heavy penalties will be the consequence.
If HMRC deem the contract to be careless, the penalty is 30% of unpaid tax. But this increases to a penalty of 70% if HMRC believes the underpayment to be deliberate. It doesn’t stop there, the penalty rises to 100% of unpaid tax if the contractor knew they were inside IR35, deliberately didn’t calculate the deemed payment and attempted to hide the underpayment. You can take a look at what HMRC have to say about IR35 penalties for themselves.
At HL&W, we advise our clients on how the system works as well as answer any questions they may have. We make it our mission to keep you clear of receiving any HMRC penalties, so you can run your business without having to worry about unnecessary fines.
Minimising the risk of an IR35 investigation
If HMRC decides to investigate, you’ll receive a letter saying they are checking your tax records and ask why you believe you are self-employed. If they don’t accept your explanation, a detailed review will take place. As part of the review, you’ll be asked to have a meeting with HMRC and your client.
But how do they select people to investigate? The first way is through a random selection process, and the second is looking for anything suspicious that might suggest they aren’t self-employed. From HMRC’s point of view, a self-employed person will be claiming expenses for the cost of running their business. Employees don’t pay these costs as they are supplied with everything needed to complete their job. In short, a limited company with a low turnover, low expenses and high dividends is at a greater risk of an IR35 investigation.
So, prepare a good explanation of your working practices, maintain good records, and have a contract in place that supports your self-employment to give you the best chance of succeeding in the event of an IR35 investigation.
As authorised agents for your company, and in case of an investigation, HL&W will receive and deal with all HMRC correspondence on your behalf. This means you can continue to work while we sort everything out and we’ll always keep you informed and provide you with accurate information.
If you have any questions surrounding IR35 or our accounting services in general, then contact us today, we’d love to help.