What is IR35?
IR35 was created to determine whether contractors who offer their services through an intermediary should be taxed as full-time employees. Contractors who operate through an intermediary are technically off-payroll, meaning they avoid paying National Insurance and income tax contributions, and the client does not pay employment tax. However, this working relationship would be scrutinised by HMRC, and if the contractor falls within IR35, both parties will need to pay taxes.
The ‘tests of employment’ were created as it can be difficult to interpret whether a contractor’s relationship with an employer is to be considered a contract of employment.
The 3 ‘tests of employment’ are as follows:
- Mutuality of obligation – Is the client obliged to offer work to the contractor? Is the contractor obliged to accept the work?
- Control – does the client have significant control over where and when the contractor carries out the work?
- Substitution – Is the contractor required to carry out the work or can be sent a substitute in their place?
To put it simply, if the contractor is free to give or take the work without penalty, then they are most likely self-employed or an independent contractor. This is also the case if the contractor has the right to send a substitute in their place.
If the contractor does not have any of the above freedoms, HMRC would consider them an ‘employee’ to the client, and they would fall under IR35.
IR35 rules: who needs to comply?
You may fall under IR35 for the following reasons:
- A client who receives services from a worker through their intermediary
- A contractor who provides their services through their intermediary
- An agency providing workers’ services through their intermediary
If you are a smaller company operating under the existing IR35 legislation you must meet the following criteria:
- Have an annual turnover of less than £10.2 million
- Have gross assets of less than £5.1 million
- Have fewer than 50 employees
How to calculate IR35
If the contractor provides services to a smaller company that operates under the IR35 legislation, the contractor would need to pay a ‘deemed payment’. This means that the contractor will take away the following from their fees:
- Any pension contributions
- PAYE salary
- 5% expenses allowance
Following on from this, they would then pay National Insurance and income tax on the remainder.
However, for the contractors who fall under the new IR35 off-payroll rules, the reforms have simplified the deemed payment, as shown in the following:
- Fees paid by the contractor are treated as a salary and considered the ‘direct deemed payment’
- National Insurance and PAYE are the taken away from the deemed salary, and the employer pays employment taxes on that salary
Therefore, instead of taking away tax from the contractor fees, employers now pay the majority of the extra tax on top of the fees paid to the contractor.
For more on IR35, click here.
