IR35 tax rules can be difficult to understand, so we have produced our latest article to addresses how the legislation operates. Read on to find out more...
What is IR35?
IR35 is tax legislation introduced to address tax avoidance by workers and the businesses hiring them by providing services via a limited company, for example. These workers would be employees of the business if they were not providing services through an intermediary, for example, a limited company and IR35 looks to tax this work on a similar level to employment.
IR35 has been in force since 2000 but has been criticised for being poorly implemented by HMRC and targeting genuine small businesses causing them unnecessary additional costs. IR35 has come into the news again since it is being replaced with the new off payroll tax which was introduced into the public sector in 2017 and is coming to the private sector in 2021. So, what is it exactly?
Let's put it into context..
Let us consider an example. Joe is an electrician and has registered a limited company to provide electrical services. Joe's limited company is contracted by Electrical Engineers Ltd. to carry out work at a factory site. Under IR35 Joe might be considered a 'deemed employee', since he could be carrying out the same work as an employee of Electrical Engineers Ltd. rather than providing the service via his own company. If Joe were considered a deemed employee, IR35 would ensure that he and Electrical Engineers Ltd. pay income tax and national insurance contributions as if Joe were employed.
IR35 was introduced as many firms were hiring workers on a self-employed basis rather than an employment contract which meant they could avoid paying National Insurance, pension contributions and the apprenticeship levy. It also meant that they didn't have to offer employment rights or benefits. Therefore, IR35 is not just about recovering lost taxes but also about defending workers' rights and offering protection from unscrupulous employers. Unfortunately, the original legislation fell short of these aims, hence the new off payroll tax being introduced now.
For IR35 to be enforced, it essentially looks to turn a one-person business into a deemed employee by looking at legislation and case law. An HMRC inspector will attempt to disregard agreements made between a worker and their client and use the real nature of the working arrangement to create a 'notional contract'. This notional contract will then be considered by a tribunal judge or an inspector to determine whether IR35 applies. IR35 will apply if the notional contract is considered to be one of employment.
The principal tests of employment are derived from the Ready Mixed Concrete (South East) Ltd v Minister of Pensions case from 1968. These are: Control, Substitution, and Mutuality of Obligation. Under the control test, the inspector will look at how much control the client has over what work is completed, when it is completed and how it is completed.
Under the substitution test, the inspector will seek to determine whether the arrangement allows the worker to send a substitute to complete the work, or whether that worker is required to complete it themselves. Mutuality of obligation is where the client (employer) is obliged to offer work, and the worker (employee) must accept it. Other factors are taken into consideration, such as whether you are taking financial risk and whether the client provides equipment or whether you provide your own.
If IR35 does apply, then the calculation for how much to pay is much simpler under the new legislation. The fees paid to the worker or contractor are treated as employment income. Income tax and national insurance contributions are deducted as if it were a salary. The client must then pay employers' national insurance contributions on top of the fee.
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