From understanding expenses to starting a limited company, our downloadable business guides can help you.
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 is owned and controlled by one person who takes all the decisions, responsibilities and profit from the business they run. You do not 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 is not such a tax efficient option as a Limited Company. As a sole trader you cannot work through an agency who will find work for you (as they are 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 are not 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 is more admin and you will likely need an accountant.
You should not consider this option if you are only intending to freelance / contract for a short time. If you are a career freelancer forming a Limited Company is a good option as you will 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 are 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.
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 is 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.
Three criteria must be fulfilled for IR35 to apply (i.e. this is what you should avoid to ensure you are not caught by IR35):
IR35 is very unpopular with freelancers and contractors and a large point of contention is that if the contractor were truly an employee, they would be entitled to normal employee benefits. Under IR35, however, the Contractor bears the tax burden but is not 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, for example 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.
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.
You might avoid a fine if a close relative died shortly before the self assessment deadline, you've been seriously ill, or if you had major IT problems.