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What Is IR35? A Guide to Its Rule & Changes

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If you’re a freelancer or a general contractor, there’s a good chance that you’ve heard of IR35. Her Majesty’s Revenue and Customs (HMRC) authority designed the IR35 tax legislation to combat tax avoidance by workers. The people that were the most affected by this were contractors and freelancers, as the rules applied to people who are “off-payroll.” If you’re a freelancer working in the public sector, having an intimate knowledge of IR35 can help you when it comes time to do your taxes. Keep reading to learn more!

Here’s What We’ll Cover:

What Is IR35?

What Was IR35 For?

Key Takeaways

What Is IR35?

The term IR35 refers to two different sets of tax legislation created by the HMRC. These pieces of legislation were designed to help combat tax avoidance by workers and the firms that hire them. In most cases, the worker provides services to their client via an intermediary. The intermediary is most commonly a limited company. If the limited company didn’t exist, then the worker would be employed by the firm using their services. This person is referred to as a disguised employee. By using the intermediary, both parties are able to avoid taxes.

If an individual that has been using this loophole is caught, they’ll have to pay both income tax and National Insurance Contributions. Having to pay income tax and National Insurance Contributions (NIC) after the fact can make a huge impact on their finances. Their net income may be reduced by as much as 25% from the payments.

The legislation has been highly criticized by tax experts. Many small businesses in the public sector have been heavily affected by IR35. Genuine contractors who have not needed to change their employment status have been targeted. As such, HMRC has implemented a new piece of legislation. This is known as the Off-Payroll Tax.

What Is the Off-Payroll Tax?

Like IR35, the Off-Payroll Tax falls under the theme of “deemed employment.” It differs from IR35, however, in the fact that the firms hiring contractors have to review the contractor’s status. Before the contractor or freelancer can provide services to clients, they’ll have to be approved. Additionally, the firm will have to pay employment taxes on top of the contractor’s fees.

Off-Payroll Tax was initially introduced to the public sector in April 2017. It’s being utilized in the private sector as of April 2021, as well.

What Was IR35 For?

The original version of IR35 was to prevent the avoidance of income tax and National Insurance Contributions. Companies were engaging with employees on a self-employed basis. These individuals weren’t actually self-employed. In reality, the employees should have had an employment status with the companies they were working for. However, to avoid taxes and NICs, the companies would hire individuals as freelancers.

Another common way that companies were avoiding taxes was by using personal service companies. A personal services company would be used as an intermediary to hire a contractor for a short period of time. This time period would generally be for a week to two weeks. Then, the individual would be released on Friday. The following Monday, they’d return to do the same job, but under a new contract. By deeming this person a consultant contractor, they’d be able to avoid paying employment taxes.

A Violation of Employment Rights

Companies would regularly violate employment rights by using only contractors. Because they would only work with self-employed people, they wouldn’t have to pay for employment benefits. Employment benefits don’t have to be paid to a self-employed contractor. Without a contract of employment, individuals were not reaping any employee benefits.

What If I’m a Genuine Contractor?

If you are a genuine contractor or freelancer, then you have nothing to fear from IR35. Should HMRC choose to investigate you for exploitation or tax avoidance, you can defend yourself. You can do this by ensuring the client company you work for follows all procedures. It is also imperative to save all documentation regarding your employment and contracts. The best defence for any sole trader or contractor is having adequate documentation.

Key Takeaways

IR35 refers to both old and new tax legislation. The original iteration of IR35 was difficult to enforce. Due to this, it ended up hurting more genuine self-employed people than it should have. The new version of IR35, also known as Off-Payroll Tax, is more structured. It is also in favour of genuine contractors rather than their clients.

If you need more information regarding taxes or tax legislation, refer to our resource hub! We’ve got you covered on a variety of subjects.