Introduced in April 2000 in the UK, the Intermediaries Legislation, or IR35, is aimed at contractors who work for clients via intermediaries.
It was created to ensure that contractors pay their taxes and National Insurance contributions as employees rather than as self-employed contractors.
Before its enactment, some contractors were using intermediaries such as limited companies to ease their tax burden and National Insurance contributions. This denied the UK government tax revenue an did not make them happy.
Here is a detailed look at IR35 and its legal implications:
In simple words, the Intermediaries Legislation or IR35 is tax legislation specifically aimed at contractors that provide services to clients via intermediaries.
Its aim is to prevent unscrupulous contractors from establishing limited companies (intermediaries) for purposes of avoiding paying taxes and NICs.
For example, this covers a contractor resigning from his/her job elsewhere and setting up a limited company that provides services in the same industry or market niche.
In fact, this was a common practice in the 1990s as the contracting industry underwent significant growth.
Unfortunately, this system cost the UK Government a lot of money in lost revenue as contract workers took advantage in the following ways:
This system allowed a contractor to take payment in the form of a dividend, which in the UK attracts less tax compared to other types of corporate taxes.
Secondly, a contractor could reduce his tax burden further by filing tax-deductible expense claims. Examples of tax-deductible expenses include private medical insurance payments, pension payments, business travel costs, and subsistence costs while away from home on business.
Thirdly, a contractor could declare retained profits that expectedly attract a low corporation rate tax. These and other reasons led to the enactment of the Intermediaries Legislation to plug these tax loopholes.
Following the enactment of IR35, the HMRC treats all payments made to a contractor via an intermediary as employment income. This means that such payments are subject to National Insurance contributions and taxes equivalent to what the contractor would have paid if employed directly by the client.
In essence, IR35 applies to self-employed individuals who offer clients diverse services via intermediaries. However, determining what qualifies as self-employment is not clear-cut and is subject to legal interpretation.
To avoid confusion, the HMRC provides guidelines aimed at clearing the ambiguity associated with the term “self-employment”. These guidelines are based on supporting factors such as:
Any contractor who provides services to clients via an intermediary and is not legally or technically an employee of either party may be subject to IR35. This is true even if the intermediary involved is registered or based abroad. In fact, in such a case, a UK based-client must make PAYE arrangements for a contractor.
According to the HM Revenue and Customs, IR35 is applicable to contractors or self-employed individuals who offer services to clients while still acting as office holders for their clients.
Every contractor and subcontractor in the construction industry is subject to this tax legislation.
The organizational/ownership structure of an intermediary company also determines whether a contractor falls under the category of contractors whose services are governed by IR35.
To understand why this is so, consider a contractor who provides services to clients via an intermediary that is itself owned/run by a third party.
According to the HMRC, such a contractor is not subject to IR35 legislation. Instead, he/she must comply with MSC legislation.
One of the aspects the HMRC evaluates in order to determine if a contractor qualifies as self-employed or not is financial risk associated with contract work. This essentially means evaluating whether a contractor bears risk of project cost overruns, cost of damages payable to client, and debt collection responsibilities.
If a contractor has complete control over the service delivery process, the contractor will most likely be required to comply with IR35.
Remember employees tend to have limited control over their employer’s business practices and processes.
On the other hand, a contractor who is in charge of his/her own business does not have to answer to anyone or worry about an overbearing supervisor.
Another factor that the HMRC considers carefully is contract features. A good example in this case is the right of dismissal. If your contracts do not have fixed notice periods, the HMRC will likely say you are running your own business.
If a work contract stipulates that there is no right of substitution, the HMRC views such an arrangement as a classic case of a business that deliberately flouts IR35.
Right of substitution simply means one can supply a substitute if he/she is unable to provide services or perform work agreed.
If a business intends to hire a contractor to offer specific services, it should expressly state so.
To be precise, it should state that its relationship with contractor is that of employer and employee or supplier and customer. By failing to make this distinction clear, such a business as well as contractor risk attracting HMRC penalties for failing to comply with IR35.
In most cases, contractors use their own equipment to perform/complete their client’s work. As such, one is likely to flout IR35 if he/she relies on work gear and equipment provided by his/her clients.
It is worth noting that complying with IR35 is not the sole responsibility of a contractor. His/her clients must also provide tax details that comply with the same legislation.
For instance, a business that hires a contractor must make the necessary PAYE arrangements regardless of whether fees for services rendered are paid to intermediary.
Moreover, the HMRC treats each contractor case individually and examines the factors discussed above to determine whether one provides services to clients as a contractor or employee.
This is in addition to reviewing feedback to more than 80 questions that the HMRC requires contractors/employees to answer substantively.
Whether you operate as a sole contractor or a partnership, it is wise to put your business through thorough scrutiny regularly to determine and reduce its IR35 risk profile as much as possible.
Since this is a highly technical and legally intensive task, you should hire a qualified and experienced legal expert to review your business’s ownership structure and practices.
Of course, the expert should have a good grasp of the UK’s corporate tax regime as well as the tax obligations of individual contractors.
One of the biggest headaches that contractors face is processing payments because of the paperwork involved that both clients and contractors must either complete or handle.
To solve this problem and more importantly, ensure you do not disregard the HMRC legislation or fail to comply with insurance coverage requirements, you can hire a payroll contractor but always remember that your business is ultimately your responsibility.
The Intermediaries Legislation is a tax and National Insurance framework that aims to prevent the abuse of the tax and National Insurance system by contractors who work through intermediaries.
Determining whether your contracting business falls under this legislation depends on factors such as the extent of control over operations, financial risk, construction industry background, equipment ownership, and contract features.
To avoid paying HMRC penalties for flouting this legislation, hire an experienced lawyer to go through your company’s incorporation documents and contract wording.