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IR35 is a potential change to tax law that affects contractors from April 2021. This guest article by Matt Fryer, Head of Legal Services at Brookson Group, explains everything you need to know about it.
One of the reasons many people choose to contract is because it gives them greater control – over their time, over who they chose to work for and over their finances. With this freedom comes greater responsibility, however, and this includes tax compliance.
Whether you’re already contracting or about to dip your toe into the water, you’ll likely have heard about the tax law IR35. If you’re confused about what it is and how it applies to you, you’re certainly not alone. This will bring you up to speed and provide you with some helpful tips on how to navigate tax as a contractor.
IR35 applies to contractors. All contractors are freelancers – but not all freelancers are considered contractors! Confusing, right?!
The main way to decide if you’re a freelancer or a contractor is to look at how many clients you work with at one time. Freelancers often have two or more overlapping clients. They can manage their own time and juggle their work between multiple projects at once. Freelancers work as sole traders or limited companies.
Contractors, however, tend to take a single contract at once. They’ll work only for that client during the time of the contract. However, the way they’re paid – before taxes and National Insurance, and not on company payroll – makes them freelancers, too. Contractors operate through their own limited personal service company (PSC).
IR35 is a rule that mostly affects contractors. Some freelancers may have to satisfy IR35 rules, too, before signing work agreements – but this is more a formality than
For a long time, many contractors used their PSC to manage their tax status. They have been responsible for their own finances, including an obligation under the off-payroll working rules – otherwise known as IR35 – for determining their own tax status and the payment of relevant tax to HMRC.
However, the Government is introducing changes to IR35 that will soon make the determination of a contractor’s tax status the responsibility of the business that hires them instead. These changes already apply for contracts in the public sector, after they were introduced in 2017. They’ll have a significant impact on the way that contractors and businesses work together in future.
The new rules have been designed to prevent businesses from hiring employees as contractors to avoid paying employee taxes. It also limits the possibility of contractors manipulating their position to pay less tax, too.
The changes were originally due to come into effect for the private sector in April 2020.First, a critical review from the House of Lords caused concern about the changes. Then, the coronavirus pandemic hit. To cope with the long-term impact of this, and consider criticisms of the HoL review, it’s been delayed to April 6th 2021. So, contractors in the private sector have another year before they change how their tax status is determined.
IR35 affects everyone who works as a contractor. For each contract you work on, your tax status will either be inside IR35 – which means that you will need to pay employment taxes – or outside IR35 – which means that you are a genuine off-payroll contractor and do not need to pay.
Whether you fall inside or outside of IR35 depends on a wide variety of factors. For example, things like whether you can send a replacement to carry out the work in your place, how you are paid, if you’re supplied with equipment and whether you receive employee benefits. To establish this, you’ll need to assess the employment status of each contract that your PSC enters into. The Government has created an online tool to help with this, called ‘Check Employment Status for Tax’ (CEST). However, given the complexity of IR35 it’s important to ask an experienced IR35 tax lawyer to examine your contract too.
It’s critical that those who identify as self-employed contractors take the time now to understand the changes and know the questions to ask their accountants, hirers and recruiters to ensure they’re working in a way that best suits them. Hirers and contractors alike should be honest and upfront about what they are looking for as part of any working arrangement, including clear reference as to whether the project falls in or outside of IR35.
Below we explore the options available for contractors both before and after 6 April 2021.
If you are found to be outside of IR35 or are seeking outside-IR35 contracts, it is worth setting up a personal service company. There are various benefits to working via a PSC. This includes being your own boss and having the freedom to choose jobs and projects that are best suited to you and your circumstances. This option also carries all of the responsibilities of running a business, though, including financial reporting, insurance and tax liability.
It offers you a more formal, professional way to present your services for hire. You’re also likely to benefit from a better work-life balance, as well as the ability to hire more people if the scope or size of projects grow.
The changes to the rules, however, have left many businesses worried about being penalised by HMRC for not making sure that the PSCs they hire have paid the correct tax. When the changes were first rolled out to the public sector in 2017, many organisations responded by making blanket ‘inside’ assessments of their contractors’ IR35 status in order to ensure compliance.
A similar knee-jerk reaction has already been seen in the private sector. Many banks already refuse to hire genuine contractors working through limited companies. In fact, our own research found that half of UK businesses (59%) would consider taking a blanket approach to managing the legislation, because they don’t have the time to assess contractors individually.
If your hirer deems you to be inside IR35 after April 6th 2021, this means that employment taxes taken from the payment for your services. It’s like your taxes and National Insurance coming out of your PAYE salary. At the same time, you will still incur the costs of accountancy fees and maintaining your professional indemnity insurance. You also have to continue filing accounts, tax returns and maintain your director’s responsibilities. So, all in all, it’s not a particularly cost-effective way of operating.
Alternatively, you could consider working via your recruitment agency’s payroll (if they have one) or via an umbrella. An umbrella is a standard UK limited company, which is operated by a third party supplier acting as an ‘employer’ on behalf of its contractor employees.
The benefit of agency payroll is that it comes at no cost to you. The benefit of umbrella payroll is that it offers you continuity of employment (if you find roles via multiple agencies), which can help with mortgages and loan applications and also avoids the fluctuations in tax codes that could arise if you work on multiple different agency payrolls. Many umbrella companies now offer other benefits such as a staff discount scheme. There is a cost to working through an umbrella company however, which varies depending on the quality of service, timing of payments to you and availability of staff benefits.
Umbrella companies first started appearing after IR35 was first introduced in 2000. However, the sector is currently unregulated, and you need to be wary of non-compliant loan schemes or similar tax avoidance arrangements posing as umbrella companies. You may be offered alternatives which seek to enhance your take-home pay. Any alternative which seeks to minimise employment taxes and maximise take-home pay carries a health warning and should be properly researched. To make sure the company you join is compliant, pick from the FCSA list of accredited providers.
While some businesses have already enforced a blanket ban on engaging with contractors working through PSCs, many more are going to want to continue working with genuinely self-employed contractors. Depending on the sector that you work in, this could mean that some contracts you apply for will be outside IR35, while others will be inside. This suggests that contractors need the flexibility of being able to switch from an outside-IR35 to an inside-IR35 project freely and easily. It’s something Brookson Group has seen as an emerging trend and have developed a new Flex service for the contractors as a result.
By finding an accountant that can handle both scenarios, contractors can avoid the confusion that comes with having to complete tax returns in different places. A joined-up tax, IR35 risk management and financial services approach will also mean that you have access to advisers with the right specialisms and real time information from all of your income sources to enable their advice to be best suited to your individual circumstances.
Brookson Group is a technology-led professional services business offering accountancy, legal, tax, payroll and back office services to the flexible workforce supply chain. As such, the Group has utilised its significant knowledge and capabilities to assist its customers in dealing with the changing world of work for over 20 years. For help about your IR35 status, get in touch on their website.
You can also ask your freelancing questions to other contractors, the Magpie team, and other experts over on our Magpie Messageboard!
Whether you’re just starting out as a freelancer or you’re already an established contractor, we’ve got plenty of articles to help you make and save money in business. Read these next!
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Good points, what needs elaborating is about tax consequences in case of an investigation.
Very informative article.