Many new freelancers and contractors may be vaguely aware of IR35, but not know when and where it applies. Before getting too intimate with the ins and outs of the IR35 legislation, the first step is to know if IR35 is even relevant to your situation. Our IR35 calculator can help.
Broadly speaking, there are three different legal structures under which a freelancer may work:
1. Be genuinely self-employed as a sole trader
You provide a personal service directly to the Client, not through any other party.
A sole trader is a business that’s owned and controlled by one person who takes all the decisions, responsibilities and profit from the business they run. You don’t have the administrative or legal responsibilities of a limited company, however you must register as self-employed with the HMRC. You are personally liable for any debts incurred in running the business. You can offset business expenses and losses against tax and need to do a yearly Self Assessment.
This is a good option if you work for a number of clients simultaneously and want to be your own boss. It’s not such a tax efficient option as a limited company. As a sole trader, you can’t work through an agency who’ll find work for you (as they’re unable to pay the genuinely self-employed ‘gross’; agencies can only pay workers via PAYE or engage with limited company contractors).
A sole trader will always be outside IR35. See our guide to making your contracts IR35-proof here.
2. Form your own limited company
Your limited company is a legal entity in its own right. You and the company aren’t the same – the company has rights and responsibilities and can own its own property and equipment. The company is liable for any debts it incurs, not you personally. You have legal obligations to publish accounts, there’s more admin and you’ll likely need an accountant.
You shouldn’t consider this option if you are only intending to freelance/contract for a short time. If you’re a career freelancer, forming a limited company is a good option as you’ll be more tax-efficient than a sole trader.
Limited companies are potentially inside IR35. Figuring out if they are is the tricky part (download this IR35 Guide for more information).
3. Use a PAYE Umbrella Company
An Umbrella Company will essentially do your payroll and tax for you.
You’re regarded as an Employee of the Umbrella Company. The Umbrella supplies you to an agency to work for a client. The Umbrella will charge you a fee for the provision of its services, and in return take care of your tax obligations.
PAYE Umbrellas are always inside IR35. If you are freelancing on a casual or short-term basis you may be better falling off within IR35 (if the circumstances apply), rather than trying to avoid it.
What is IR35?
IR35 came into force in April 2000 and affects all contracts that the self-employed work under that do not meet the HMRC’s definition of self-employment. It’s legislation that effectively allows HMRC to treat some contractors as employees, and tax them (and take National Insurance contributions) accordingly, when they judge that they are employees in all but name (if there was no intermediary). It was bought in to ‘eliminate’ the avoidance of tax and NIC’s through the use of ‘intermediaries’ such as personal service companies or partnerships, and continues to be controversial.
In July 2014, the HMRC updated their IR35 guidance which you can see here and published FAQ which you can see here.
Three criteria must be fulfilled for IR35 to apply (i.e. this is what you should avoid to ensure you’re not caught by IR35):
- The freelancer must personally perform the relevant work for the Client
- An intermediary company must be used (e.g. a personal service company/limited Company/formal partnership or recruitment agency – but not a Managed Service Company) rather than the freelancer contracting directly with the client
- The terms of the arrangement must be such that the freelancer would have been treated as an employee of the client for NIC purposes, were they to have been contracted directly. HMRC recently published an Employment Status Manual which gives detailed information about defining your status, which you can see here. HMRC will consider the written contracts between the parties but the actual reality of the working relationship is crucial
The implications of IR35 for the self-employed (and the reasons IR35 is sought to be avoided)
- If the contract would otherwise be treated as one of employment under the current Employment Status rules, any fees paid by the client to the freelancer will be treated as employment income for Schedule E Income Tax and NIC purposes, following deductions for expenses. Income will be in the form of a ‘deemed payment’. The updated HMRC Guidelines give information on how to calculate this payment. Tax and National Insurance contributions are payable on this amount by the intermediary
- You and your intermediary will need to consider whether the IR35 legislation applies to each engagement – and if the contract is changed or altered in any way, it should be reassessed for IR35. Whether IR35 is applied isn’t dependant on what you ‘call’ yourself – e.g. self-employed, freelance, contractor, consultant
- The intermediary is responsible for ensuring IR35 legislation is applied (not the client/end-user)
- This results in a reduction in take-home pay for many freelancers and may mean you pay more tax than a permanent employee
- ‘Administration’ expenses claimed on the part of the contractor are limited to 5% of gross fees (which includes premises costs, admin support, accountancy advice, costs of seeking contracts, insurance, training costs, computer equipment etc). However, certain expenses for pension payments, business travel, subsistence (meals and accommodation when away from home), Professional Indemnity cover and benefits in kind (e.g. private medical insurance) can be claimed in addition to the 5% allowance
- Furthermore, offsetting the costs of sickness, holiday pay, training and so on aren’t allowable under IR35
- If you ignore IR35 and HMRC enquiries into your situation you may be charged interest and penalties on unpaid/late paid tax and NICs.
IR35 is very unpopular with freelancers and contractors and a large point of contention is that if the contractor were truly an employee, they’d be entitled to normal employee benefits. Under IR35, however, the Contractor bears the tax burden but isn’t entitled to the full rights and benefits of employment. The Agency Workers Regulations that came into existence in October 2011 goes some way to provide basic employment rights to those contractors who are Agency Workers (which contractors caught under IR35 legislation, e.g. those that work through an Umbrella Company are likely to be).
So, the legal structure under which you operate as a Contractor will partly depend on your IR35 position – read our article here about how to make your contracts IR35-proof.
- More delight for Contractors as Consultation on IR35’s effectiveness was launched in July 2015. With HMRC believing that many PSC’s don’t comply with IR35, the consultation gives 2 options: putting the burden of determining whether IR35 applies on the engager/end-user rather than the PSC (so the engager would be liable for PAYE/NI if IR35 did apply); basing the IR35 test solely on whether a 3rd person exercises supervision, direction or control over the way in which the worker provides his services (so they fall into IR35). There’s large concern that if this was implemented it may take away the tax advantages of using a PSC vehicle.
- Removing tax relief on Travel and Subsistence Expenses where a worker is employed through an employment intermediary and works under the supervision, direction and control of any person. Consolation ran from July to September 30th, and becomes law on 6th April 2016 – you can read more details here.
You can use the Crunch IR35 Calculator to assess your IR35 status and the HMRC Guidance also provides information on how to work out if IR35 applies to you.
If you are an Employer and need ongoing professional help with any staff/freelance issues, or a Contractor/Freelancer/Employee with a complicated employment related problem, then talk to Lesley at The HR Kiosk – a Human Resources Consultancy for small businesses – our fees are low to reflect the pressures on small businesses and you can hire us for as much time as you need.
Please note that the advice given on this website and by our Advisors is guidance only and cannot be taken as an authoritative or current interpretation of the law. It can also not be seen as specific advice for individual cases. Please also note that there are differences in legislation in Northern Ireland.