IR35 - an overview

In 1999 the then Inland Revenue published a press release entitled “IR35: Countering Avoidance in the Provision of Personal Services”, the reference number of this press release was IR35. Such was the impact of this press release, although the guidance note that accompanied its implementation was referenced IR56, the Legislation it introduced became known from that point forward as “IR35”.

In the Inland Revenue’s own words: - “The purpose of the rules was to remove opportunities for the avoidance of tax and Class 1 National Insurance Contributions (NICs) by the use of intermediaries, such as service companies or partnerships, in circumstances where an individual worker would otherwise be an employee of the client or the income would be income from an office held by the worker.”

IR35 became law via Schedule 12 of the Finance Act 2000 - its prime aim was to ensure individuals, specifically Freelance Contractors, working via limited companies would be subject to the same taxation laws as an individual performing the same task whilst employed under the PAYE system, rather than receiving income in the form of a small salary and large dividend payments from a Limited Company.

The rules surrounding IR35 are complex, but it is important that they are fully considered and the appropriate pay method is applied to your earnings, as all Limited Company Directors are required to submit a tax return to Inland Revenue, now Her Majesties Revenue and Customs (“HMRC”). This means that HMRC are fully aware of the working status you are claiming and are able to conduct investigations into your employment status. If they are not convinced that you are truly in business on your own account, they have the power to make you pay the full amount of underpaid tax and charge additional penalties.

A person who works 9-5 on a client site, has little or no direct responsibility and provides no tools of his own to complete a task would most likely be deemed as ‘employed’ by HMRC and therefore subject to the IR35 rules. However, a contractor who is able work from home as well as at a client site, performs tasks for multiple clients and uses his own equipment to complete the work would more likely be deemed ‘self employed’ under the IR35 rules. In determining employment status HMRC look at the overall picture, including the specific contracts in place between all parties as well as the way a person provides their services to a client, so to be sure of working outside of the IR35 rules, the more pointers there are to genuine ‘self employment’ the better.

A Limited Company Director, who is genuinely working outside of the IR35 rules, is able to receive income from their Company in the form of dividends which allows for a significant saving in tax and National Insurance against full employment income. However, if a person is caught by the IR35 rules, the income they receive from their company will be classed as a ‘deemed payment’ which means that with the exception of a fixed 5% allowance to cover intermediary expenses, all income will be subject to deductions of PAYE and National Insurance. Genuine business expenses, such as insurance premiums and accountancy fees can still be offset against taxable income, but no dividends will be allowed.

Although HMRC have found it difficult to implement the IR35 legislation, with many cases being successfully contested by Contractors, getting it wrong can prove very costly; in the recent Dragonfly case, which considered whether the director and owner of Dragonfly Limited was a disguised employee of his clients business for certain assignments he worked on and therefore working within IR35, the Judge in the High Court found that he was working within IR35, which resulted in a £99,000 bill for unpaid tax.

To ensure that you don’t fall foul of the IR35 rules, we would always advise taking professional advice,

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