What is IR35? – We Explain what it is and whom it catches

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IR35 Legislation
IR35 Legislation

IR35 Legislation

IR35 was set up to catch disguised employees. That is, those leaving a company on a Friday and returning as a contractor on the Monday. It was to make sure that they paid their fair rate of tax.

Many of those who are new to IT contracting may wonder what IR35 is and how it will affect them. We explain here.

Previously, most contractors, especially IT contractors, generally used limited companies. They pay their income into it. They extract expenses and salary from it before paying both Corporation Tax and personal tax.

Several years ago, the Government decided that some classes of contractor were really not contractors at all.

What they were really looking at were those people who were permanent on the Friday at a company and the next Monday they had become contract staff.

They felt, probably correctly, that these were disguised employees. They decided that this was just a ruse on the part of the company and the new ‘contractor‘ to avoid taxation.

caught by ir35
Caught by IR35

New Law Brought In

Therefore they brought in IR35 to put this right.

What would happen in the future, said the Government, is that all those companies who were really small businesses, including IT contractors, would continue to be looked at as small businesses and treated accordingly for taxation purposes.

However, they would tax those who were really disguised employees according to Government thinking, as if they were employees.

They would not be allowed to claim any more than 5% of their income as expenses. Then they would pay tax at the full rate.

Caught in the Net

However, the new rules caught out more than it was thought that they were intended to catch.

In fact formal Paymaster General, Dawn Primarolo, said as much at a working breakfast with the Professional Contractor Group (now IPSE).

She said that the law was catching out more than it should have done.

It meant that many contractors were potentially inside it.

The Professional Contractors Group, indeed, was set up to fight this new piece of legislation and to lobby for its abolition.

Contractor Tax Options

IR35 Government Moneyspinner
IR35 Government Moneyspinner worth £2 billion a year

Nowadays it looks like contractors have gone down one of three routes:-

1) They have simply paid up their full whack of tax
2) They have joined an Umbrella Company which allows them to deduct expenses
3) They have continued to trade as limited companies without paying IR35.

The Professional Contractors Group fought a High Court case, funded by contractors, which they lost.

They then lost an appeal, again funded by contractors, at the High Court.

They also lost an appeal against the General Commissioners verdict on an IR35 case at the High Court.

Government and HMRC

However, along the way they learned a lot about how the Government and HMRC thought about IR35 and who it would include.

They also learned a lot about how the judiciary and the Special Commissioners and General Commissioners would view who was inside IR35 and the correct route to take when fighting a case.

It is this information, gleamed from what might be classed as failures, that has allowed more and more contractors.This gives them the information that will help take them outside of this tax.

Contractors are far more flexible than the Inland HMRC. They can change their contracts with agencies and clients to get their contracts classified as being outside this tax.

Financial Difference of IR35
Financial Difference of IR35

Inside or Outside IR35

In fact that is a very important point to make. Contractors are not inside or outside IR35. It is contracts that are in or out.

It could be that a contractor has three contracts in a row, where the first is outside, the second is inside, and the third is outside again.

The Professional Contractors Group continues to lobby for the abolition of IR35 or at least for more classifications of contractors to be outside of the tax.

They are having more and more success as fewer and fewer contractors are now paying the tax. They achieve this by either putting themselves inside Umbrella companies, or by staying as limited companies and changing both their contracts and working conditions so that they are outside of IR35 and don‘t have to pay tax as disguised employees.

It is important to note that these so-called disguised employees get none of the benefits of being an employee but are only considered as employees for taxation purposes.

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