Contractors guide to IR35
The IR35 rules are designed to prevent people from avoiding tax and National Insurance Contributions through the use of personal service companies or partnerships. The rules don't prevent people from using these structures to self their services to clients, but they do remove the tax advantages from doing so.
These tax advantages mainly arise from the ability to extract profit from your personal service company using dividends. This avoids any National Insurance Contributions which would have been due on a salary or bonus. The intention of the rules is to tax most of the income of the company as if it were the salary of the person doing the work.
When does it apply
The rules apply if the person supplying the services would have been classed as an employee if he or she had been self-employed. It enables HMRC to "look past" the fact that a limited company or partnership has been used to supply the services.
Unfortunately it's a complex matter, often involving case law, to establish whether work you've done constitutes employment or self employment. These factors are relevant to concluding that an employment relationship exists:
- Mutuality of obligation: There's an ongoing understanding that the client will offer work and the contractor will accept it.
- Control: The client has control over how the work is done - what tasks are involved, what hours are worked etc.
- Equipment: The client provides all necessary equipment.
- Substitution: The client has the right to insist that the contractor does the work themselves, and can veto the use of a substitute.
- Financial risk: The contractor bears little financial risk (e.g. no obligation to fix mistakes in their work on their won time, or take responsibility for the consequences of errors).
- Basis of payment: The client pays a daily or hourly rate for the contractor's contribution, rather than a fixed price for the project.
- Benefits: The contractor is entitled to sick pay, holiday pay and expenses.
- Personal factors: The contractor works for a single client, rather than supplying a number of different clients. This is especially important if the contract between the client and contractor prohibits working for other clients.
The rules apply only if:
- More than 5% of the ordinary share capital of the company is owned by you or your family, or if your or your family are entitled to more than 5% of the dividends, or if you are in a position to receive other payments or benefits from the company that are not subject to PAYE but represent payment for the services you have provided to your clients.
- For a partnership, you or your family must be entitled to at least 60% of the profits, or if work for one client generates most of the partnerships' income, or if your profit share reflects the payments received by the partnership from your own clients.
Given the complexity and judgement involved, it's essential that you seek professional advice on your specific circumstances.
Burden of responsibility
At present, the burden of responsibility for deciding whether an employment relationship exists depends on who the client is. All public bodies, including local and national government and state owned companies such as the BBC and Chanel 4 are responsible for deciding whether IR35 applies to their contractors. If they decide that they are, the contractor (or their agency) will be required to account for the tax and National Insurance Contributions.
At present, different rules apply in the private sector. Here responsibility sits with the contractor, although there is currently a government consultation on whether this should remain the case, or that the rules about public bodies should be extended to the private sector.
The consequences of IR35
If IR35 applies, your company operates PAYE and NIC on actual payments of salary, benefits or bonuses to you in the normal way. At the end of the tax year your salary, benefits and bonus need to be compared to the company's income within scope of IR35. The difference, after deducting allowable expenses, is deemed to be an additional salary paid on 5th April and on which PAYE and NIC are due. For example a difference of £10,000 is treated as salary of £8,787 (on which the contractor has to pay income tax and employees NIC) and employers NIC of £1,212. Note that:
- Income and expenses are calculated based on actual receipts / payments during the tax year.
- Where the company is VAT registered, the amounts net of VAT are used in deemed payment calculations and VAT is accounted for as normal in the company's VAT returns.
Where salary is "deemed" in this way, the deemed payment (including employers NIC) is an allowable expense for corporation tax. Since the payment is deemed to have occurred on 5th April, tax relief is given sooner if your company's accounting date is also 5th April.
Since a partnership can't pay a salary to a partner, all the income within scope of IR35 (after allowable expenses) is treated as a deemed payment on 5th April. This is then treated as an allowable expense in calculating the tax position of the partnership.
- Certain capital allowances
- Employer pension contributions
- Employers National Insurance Contributions, including those due on the deemed payment
- Normal employment expense (e.g. business travel).
- 5% of the gross income, as a general allowance for other expenses.
Impact on how you extract funds from the company
Since you have a number of ways of extracting profit from your company, you need to consider how these interact with the deemed payment:
- Salary - if you extract all your profit as salary or bonus payments there will be no deemed payment to make. The disadvantage is that your company needs to make PAYE and NIC payments throughout the year.
- Director loan - alternatively you can take cash out of the business throughout the year using a director loan, which is repaid out of your deemed payment on 5th April. This means no tax payments during the year, but will result in tax and NIC's on the notional interest on the loan. Keep in mind the requirement that loans are repaid within nine months of the company's year end, in order to avoid paying further Corporation Tax at 32.5%.
- Dividends - payment of dividends is often the most attractive route. The company will pay tax and NIC's on the deemed payment in the normal way, and can then make a claim for the dividend not to be treated as a dividend for tax purpose in your individual tax return. This avoids double taxation.
RTI and PAYE requirements for deemed payments
The deemed payment is treated as if an actual payment had been made on the 5th April. This means that tax and NIC's need to have been paid to HMRC by the 19 April and that final RTI submissions, including the deemed payment, are submitted by 19 April.
If a provisional payment of tax and NIC's has to be made because it's not possible to calculate the deemed payment and related deductions in this time, and adjustments should be reported via an Earlier Year Update submitted electronically before the next 31 January. However interest on any overdue tax or NIC's will be chargeable from 19 April.