What Is All The Fuss About IR35?
This question always comes up. “You know I am a sole trader, I was talking to someone (usually in the pub) and they told me I should be a limited company and I will save tax?” But – it’s never that simple and it depends on your circumstances. If you are just working for one contractor then it is even more complicated.
If you are a subcontractor working through your own limited company then you need to determine whether your contract falls outside or inside IR35 on a contract by contract basis.
What is IR35?
IR35 is basically the tax legislation to tax disguised remuneration at the same rate as if treated as employed income.
What is inside and outside IR35?
Essentially, if you have the same benefits, responsibilities and control as an employee, then you are more than likely to be classed as inside IR35. Some of the key factors that determine if you’re inside or outside IR35 are control, financial risk, substitution, provision of equipment, right of dismissal and employee benefits.
Whether you are caught by IR35 or not is about proving you are in business on your own as opposed to being an “employee” of the contractor.
The financial difference between being inside or outside IR35 can potentially be huge. If you are outside IR35 this means that you can pay less tax & National Insurance (NI).
If you fall inside of the IR35 legislation it means that you have to operate the majority of your pay as salary “deemed salary” which attracts tax & NI at the same rate as an employee.
If you operate outside IR35 and are subsequently investigated and HMRC win their case you will have to pay back the tax as if you had operated a “deemed salary” plus penalties and interest.
If you are inside IR35, there are still some offset expenses:
Normal Section 198 expenses may still be claimed. In addition, there is a provision for other intermediary expenses of 5% of a contractor’s turnover.
The following expenses can therefore be claimed in addition to the 5% allowance:
- Pension payments – either personal or executive schemes
- Business travel – incurred in the course of business duties
- Subsistence – accommodation, meals when away from home
- Professional Indemnity cover
- Benefits in kind – e.g. private medical insurance
Sole traders are outside IR35
Although you will not be caught by IR35 when trading as a sole trader (in most cases, so always seek advice), you will still need to look at the wider picture.
If HMRC reviews your engagement with a contractor who makes regular payments to you in your name, HMRC will question the nature of the engagement. HMRC can treat engagements as an employer/employee relationship even though ‘you’ the sub contractor are operating as a sole trader and not as a limited company.
HMRC will be of the opinion that ‘you’ have not been paid through PAYE but there were regular payments, and even if ‘you’ pay the self-assessment income tax and class 4 national insurance on the profits made, HMRC will still look to recover NI contributions and interest from the contractor who would be classed as the employer. HMRC will also charge a penalty in most cases stating that the NI contributions were not paid on time. The contractor will have to pay.
This is why contractors prefer to hire limited companies as basically the liability if any will fall on them.
In summary, this is a very complex area depending on your circumstances, there are some savings to be made, depending on your method of trading, but remember setting up and trading as a limited company is going to be more expensive in professional fees, always take advice.
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