If you are setting out as a self employed sole trader there are many pitfalls out there that can catch you unawares, just one of these is the IR35 Tax legislation. In April 2000, schedule 12 of the Finance Act 2000, also known IR35, was passed into law. IR35 was a controversial piece of tax legislation to many people both when it was introduced and even now by the government to tax ‘disguised employment’.

A little bit of history

Before IR35, contractors who declared themselves self-employed could offer personal contracted services to their clients through their own intermediary, personal service company or limited company. This allowed contractors to have an employment contract with their clients that could be classified as them being employed, all the while maintaining the tax privileges of their independent status.

This ment that the contractor was able to reduce the amount of taxes and Class 1 National Insurance Contributions (NIC) that other ‘normal employees’ would be required to make. IR35 was instituted to expose these ‘disguised employees’ and close the tax loophole to even the playing field for all employees and contractors.

Although there have been many governmental discussions about abolishing the legislation as many feel it is poorly defined, IR35 still remains in effect and has repercussions for anyone planning to start a company that need to be considered.

How could it effect me?

If you have the misfortune of falling foul of the IR35 legislation it can have a devastating effect you weither you are a freelancer, contractor or self-employed. The HMRC are entitled to audit accounts for up to six years in arrears and can force a contractor to pay any unpaid taxes in as little as three to six months. Tax obligations under the IR35 schedule can also increase by 25% or more, forcing contractors to increase their rates to compensate for the income shortfall.

IR35 legislation is complicated enough that a specialist contract accountant should be hired to review any contract to determine if it is subject to IR35. The HMRC are responsible for investigating and auditing contracts between contractors and clients, and use a complex scheme to determine the precise relationship between the parties specified in individual contracts.

For IR35 rules to apply, you as an individual would have to perform the service personally for the client, but not directly. The contract would involve the services to be rendered through an intermediary, normally your personal service or limited company.

The contract would have to be set out in such a way that if you had provided the services directly to your client, you would be classed as employed.
IR35 rules apply to individual contracts rather then directly to a person, intermediary or limited company so it is entirely possible that some contracts may include IR35 taxable income and others may not. Also, IR35 does not define ‘self-employment’ the entitlement to a 5% expense provision is not reduced even if a contract is deemed IR35 taxable.

Self-employed individuals need to make sure they have several clients and think about the following points to work out if they actually pass the ‘IR35 self-employment’ test:

  • Is it my responsibility if the service is performed poorly?
  • Do I have complete control over the work performed? – i.e – Do I choose what hours/days I work up to the contracted amount, do I choose what work to do and when?
  • Is there an actual physical business?
  • Are there other employees?

If you are struggling to work out if you are going to be classed as employed or self employed by your contract then the HMRC provide a useful tool, in the shape of their status checker to let you know how they would deem your contract.

If you don’t want to set up your own business it would be looking at using an “umbrella company” – despite the fees they charge it is often a good short-term option. By using an umbrella company, you effectively become a PAYE (Pay As You Earn) employee of the umbrella company, thereby making your employment status completely transparent to the HMRC, which is an absolute must for you to comply with the IR35 regulation.

Provided that you are not treated as a permanent employee of the umbrella company you can still remain outside the scope of IR35. An added advantage is that the umbrella company completes your expense and tax reports, freeing you from the stress and worry of doing so yourself. However, there are disadvantages of working for an umbrella company, as it can significantly reduce your control.

So it is important to carefully consider your options, and ensure you seek specialist advice from an accountant that specialises in IR35 to determine if joining a PAYE umbrella company would be your best course of action or not.