IR35: Are You In the Know or Out of the Loop?

We look at what the IR35 legislation is and how it affects you small business

IR35: Are You In the Know or Out of the Loop?

IR35 is a piece of legislation that was introduced more than a decade ago but it still manages to confuse a number of people. British chancellor George Osborne mentioned IR35 in his December statement saying he believed it to be fit for propose but in need of some slight adjustments; so expect IR35 to big news in 2013.

Since 1999/2000 IR35 has been in place to prevent individuals from falsely claiming to be independent contractors for tax benefits. Prior to this legislation it would have been possible for an individual to be employed by a company, then leave and set themselves up as a contractor only to return to the same company and do the same job but without paying regular levels of income tax. To combat scenarios like this, IR35 sets out a number of guidelines to determine whether someone is genuinely independent or feigning contractor status.

Inside or Outside of IR35?

TAP - IR35 legislation

(Graphic supplied by The Accountancy Partnership)

If a contractor is considered to be outside IR35 then HMRC assumes them to be genuine. This means the contractor will pay corporation tax like a ltd company as opposed to PAYE like a normal employee. To be found outside IR35, a contractor will typically:

  • work without an immediate boss
  • be paid a set amount for a set job
  • have financial responsibility for the quality and timeframe of their work
  • be able to perform a job with their own tools and equipment
  • receive no employee benefits

If the above does not apply then a contractor is likely to found inside IR35 and therefor expected to pay PAYE and regular NI contributions like an employee.

The Problem

The reason IR35 becomes confusing is because contractors work on a contract to contract basis and not every contract they enter will be the same; meaning some contracts they enter will inevitably tread into grey area with IR35. This is why small businesses need to be aware of IR35 in relation to the contracts they offer.

Business Entity Tests

HMRC’s business entity test (146k PDF) is a points based system that will allow contractors to find out if they are inside or outside IR35. Upon taking the test, contractors will be awarded a rating of high, medium or low risk and those with a low risk rating are likely to be free from HMRC’s scrutiny.

It would be in the interests of any small business that uses contractors, or is involved in contracting, to have a look at the criteria for the business entity test because it will let them know what HMRC will expect from both contractors and the contracts they enter into.

If businesses make their contracts IR35-proof and contractors take their time to understand the legislation then IR35 needn’t be the headache that it seems to be for many people who work independently.

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