How does IR35 affect limited companies and contractors?
At Future Strategy, the question ‘How does IR35 affect limited companies and contractors?’ has become one of our biggest enquiries.
IR35 is a piece of legislation that assesses whether a contractor is a genuine contractor or a ‘disguised’ employee – so they can gain tax benefits.
Those contractors who work through their limited company will enjoy some tax efficiency over standard employees.
While they don’t receive employee benefits such as sick and holiday pay, they have flexibility and control over their work.
Changes to IR35 are coming into force in April 2021, which will affect many people operating as a limited company.
What changes are happening in 2021 with IR35, and how will IR35 affect limited companies?
IR35 (or the ‘off-payroll working rules’) was introduced by HMRC in 2000 to tackle what it calls ‘disguised’ employment.
But for years, it was ineffective, and non-compliance with the rules was widespread.
So in 2016, the Government announced a crackdown on contractors working with the public sector.
And on 6th April 2021, that same clampdown will be enforced on the private sector – meaning contractors working as limited companies need to make sure they play by the new rules.
What do the IR35 changes in 2021 mean for contractors?
If you are not compliant, you may be forced to close your limited company or make significant changes.
Why is IR35 being enforced?
Some contractors (and their hirers) may try to take advantage of the tax efficiency of working through a limited company when the contractor is actually working as an employee.
The benefit of hiring workers in this way is that employers don’t need to pay National Insurance (NI) contributions or give employee benefits to contractors. In addition, tax efficiency is a benefit for contractors.
What IR35 does is assess whether contractors are, for all intents and purposes, employees when they take on work for clients.
If you’re ‘inside IR35’, HMRC will see you as an employee, and you’ll face an income tax and NI burden, the same as employees. If you’re ‘outside IR35’, you won’t face this.
Many people find that this legislation is difficult to understand. The lack of clarity, together with ambiguity over employment status guidelines (including the available employment rights if contractors are found ‘inside IR35’), has proven controversial since the law’s introduction.
If you’re worried about the changes, it is highly recommended to contact experts in the field who can help you with your business.
At Future Strategy, we are already dealing with a significant number of businesses that need to make changes.
When does IR35 apply to Limited companies?
HMRC states that when determining whether IR35 applies to a contract or engagement, “you must work out the employment status of the person providing their services.”
The ‘off-payroll working rules’ also say that only apply if the contractor “would be an employee if there was no intermediary.” This intermediary, in most cases, is the Limited company of the contractor (often known as a personal service company).
HMRC has a tool that you can use to check whether IR35 applies to a contract – the Check Employment Status for Tax (CEST), as well as an IR35 helpline.
How can firms and contractors avoid IR35?
There’s no way that firms can circumvent IR35 other than choose to hire all its contractors on fixed-term employment contracts – which essentially means hiring them as if the IR35 applies and paying all the extra employment taxes.
However, this would be an expensive way of eliminating the IR35 issue, and it’s improbable that a company could renegotiate the kind of rate cut necessary with all its existing contractors to offset the new taxes.
IR35 does not apply to companies that hire self-employed contractors.
However, that won’t prevent HMRC from launching an investigation at a later date, which can be costly, stressful, and highly time-consuming,
Am I compliant?
If a contractor wants to determine whether or not IR35 applies to their contract, there are several principles to consider.
In general, IR35 will not apply if the contract is for services rather than employment. However, here is a checklist to consider:
- Control, direction, supervision: This point relates to how much say a client has over how you complete your work. For example, if you’re required to work at certain times, this implies some level of employment.
- Substitution: Could you bring in someone else to complete the contract, or do you need to carry out the work yourself? If you’re unable to send somebody else, you’re likely to be ‘inside IR35’.
- Mutuality of Obligation: Does your employer have an obligation to offer work, and do you have to accept? This is known as Mutuality of Obligation (MOO), and if it exists, the contract will fall ‘inside IR35’.
Are there any other factors to consider?
When determining your IR35 status, it’s crucial to ensure that you assess your relationship with your employer before you start a contract by considering all of these principles:
- Business ‘on your own account’: This essentially determines whether or not you’re running your business as an actual business. If you have facilities such as a website, a dedicated office space, and even employees, you could be seen to be operating a business and not offering services in the same way as an employee would.
- Equipment: HMRC often tries to argue that you are a ‘disguised’ employee if the client provides your equipment and you don’t use your own.
- Exclusivity: Do you carry out work for any other clients? Typically, self-employed people can work for multiple clients at a time.
- Financial: Self-employed contractors usually accept a degree of financial risk, similar to any business. Are you responsible for any errors made during your contract, and would you need to use your own time to rectify them? There’s normally a requirement to have professional indemnity insurance in place.
- Intentions of the parties: Your contract should ensure the relationship between contractor and client is genuinely one of supplier and customer. If HMRC finds that the actual intended relationship is more like an employee and employer, it will ignore the contract.
- ‘Part and parcel’ of the organisation: If contractors become so involved that they become a part of a company’s structure (i.e., with people reporting directly to them), this points to them being employed rather than self-employed.
- The way in which you’re paid: Self-employed workers are paid on a project basis, which might mean when the job is completed or at particular milestones of the project.