IR35 is a UK tax legislation which aims to close a loophole in the tax system whereby workers could pay less tax by setting up a limited company than they would if employed.
Some of the criteria used to determine whether someone is inside or outside IR35 is common sense; if you act like and are treated like an employee you should be taxed as one. However, there are a lot of grey areas in the legislation and some points which may seem relatively insignificant can have a major impact. Therefore it's always best to consult an expert before making any decisions over your IR35 position.
As of 6th April 2021, the new off-payroll working rules are in place. This means that the IR35 determination process has changed for those engaged to a medium or large client in the private sector. These changes have already been in place for the public sector since 2017.
IR35 rules are closely wed to contracting work. If you work as a contractor through a limited company you can pay corporation tax at 20%, claim business costs against your tax bill and avoid making National Insurance Contributions (NIC) by paying yourself through dividends.
Working as a contractor is often more tax efficient set up than working via an umbrella company or as an employee of a company. However, many contractors are working in the same way as employees and gaining a tax advantage over those working in the same manner as them but through PAYE.
What does inside IR35 mean?
To be operating inside IR35 means that, under the IR35 legislation, you must pay the same tax as an employee. This could also mean that you are entitled to the same rights entitled to employees such as minimum wage, maternity pay etc.
If you're found to be working inside IR35 you will typically have to pay a deemed payment of income tax at the end of the tax year to account for any tax deductions or National Insurance Contribution that an employee would have paid.
What does outside IR35 mean?
To be operating outside IR35 means that the IR35 legislation does not apply to you. This means that that you can pay yourself a salary and withdraw further income as dividends whilst your limited company pays tax only on its profits at 20% rate.
Things that indicate you are outside IR35 and are operating like a business include having your own business insurance, marketing yourself via a professional website, owning your own equipment and working for multiple clients.
If you are operating outside of IR3 and take dividends from your company, you run the risk of being on the receiving end of a HMRC IR35 enquiry. HMRC will review your contract and the actual working practices to determine whether or not the correct amount of tax has been paid.
If they decide that you are a disguised employee working for a small client in the private sector, you will be required to make a deemed payment, paying back all the tax and NI you would have paid if you were an employee as well as interest and a possible penalty.
A HMRC investigation will begin with a request for information relating to a specified accounting period and require evidence as to your IR35 status. Investigations can range from a few weeks with no further information required to years of back and forth and possible appearance at a tax tribunal.