Understanding IR35 for Contractors: Off-Payroll Rules Explained
When HMRC introduced IR35, it created considerable upheaval for countless professionals working in the construction sector, given the large proportion of tradespeople who were suddenly unable to consider themselves independent businesses or self-employed.
The principle is to ensure that anyone paid as a self-employed contractor or through a limited company is recognised correctly. This aims to ensure all contractors and developers pay the right amount of tax and prevent organisations from avoiding mandatory employee benefits.
However, IR35 remains misunderstood and, as the specialist contractor accountancy team at James Todd & Co explains, the repercussions of getting it wrong can be serious.
Recapping the IR35 Rules for Contractors and Construction Businesses
IR35 is a set of rules that act as a checklist for organisations and contractors to determine whether they are, indeed, independent contractors or have a relationship with the hiring company that means they are, in effect, acting as employees.
This impacts a huge number of tradespeople, with many opting to trade as self-employed individuals or limited companies given the advantages from a tax perspective.
For instance, a contractor who sets up a limited company pays corporation tax at 19% on the small profits rate up to £50,000 and can lower the cost of national insurance by paying themselves via dividends rather than as a salary.
Both contractors trading as self-employed businesses and those who operate as limited companies can deduct the costs of doing business before arriving at a taxable profit – something that can make a significant difference when accounting for expenses like equipment, PPE and travel.
HMRC set out to remove these options when a contractor is linked to the client in a way that means they should be paid – and taxed – as employees. The hiring business is obligated to declare whether IR35 applies, unless the company is small and in the private sector, in which case the contractor is tasked with determining their tax position.
Clarifying When IR35 Regulations Apply
The tax office describes those who fall under the IR35 umbrella as being ‘inside IR35’, which means they are liable to pay the same tax on their income as an employee. They also become entitled to protections and benefits that employees receive, such as minimum wage, paternity, and maternity leave.
IR35 provides several criteria, but in summary, these set out scenarios where the contractor works predominantly or only for one client, works for one organisation over the long term, is supervised by someone within the client organisation, and works at the client’s premises.
In contrast, contractors who can delegate work to others, who are paid on a project basis rather than based on their time, have the right to decide when they work, supply their own equipment or materials, and work with multiple clients or one client at a time, are typically outside IR35.
What Happens if a Contractor is Deemed as Inside IR35?
If you, as a contractor, determine that IR35 applies, you must declare this to HMRC. If a client company assesses your position and finds that you are subject to IR35, you will receive a document called a Status Determination Statement.
In either situation, the contractor becomes a deemed employee of the client company, which must manage employer national insurance contributions, tax and national insurance deductions from the contractor’s pay.
If you’re found to be subject to IR35 part-way through a contract, you may be obligated to make an additional payment at the end of the relevant tax year, covering all of the tax deductions and national insurance contributions that would have been paid to HMRC from your income related to the contract.
However, it is important to clarify that HMRC can and will launch investigations if it has reason to suspect a contractor is technically considered an employee or is ‘off-payroll working’, which involves an in-depth review of your contracts, tax returns and relationship with the client.
Any contractors found to be paying tax incorrectly, either inadvertently or intentionally, can be investigated. However, if the tax office believes they have acted negligently, the investigation can be extended by backdating it by as much as six years.
How Does HMRC Penalise Contractors Not Applying IR35 Correctly?
Penalties can be levied against the contractor and the client business, including 100% of the unpaid tax HMRC calculates as payable.
It can also levy punitive fines from 30% to 100% of the unpaid tax, depending on whether the tax office believes the compliance failure was deliberate, in addition to interest accruing from the original date taxes were owed.
In every case, if you suspect IR35 does apply, it’s strongly advisable to review your tax position with assistance from a knowledgeable accountancy professional, because even if this means your tax obligations increase, the cost of non-compliance will be substantially higher.
Professional Advice for Contractors and Construction Businesses Concerned About IR35
We recognise that IR35 can be regarded as an inconvenience that contractors can disregard, as the potential for an HMRC investigation might be perceived as low, or because professionals believe that the reductions in tax obligations are so beneficial that they are willing to take the risk.
Our advice is to be very cautious if you think you might be deemed an employee, because the impacts can be severe and include non-financial consequences.
Those range from reputational damage to automatic exclusion from bidding for certain contracts. Other outcomes include possible contractual breaches and the associated legal liabilities, as well as ongoing scrutiny from HMRC.
At worst, contractors who the tax office thinks have deliberately tried to conceal their tax status for IR35 can be subject to heavy fines. These can be equivalent to 200% of the tax they should have paid as an employee, which for many is a business-critical cost.
Taking action by speaking to our experienced contractor accountants is the best way to protect your business for the long-term, ensuring you know with certainty whether IR35 applies or not, can budget and plan for the changes in your tax liabilities, and make informed decisions about new contracts or proposals with full oversight about whether this might change your tax position.
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About James Todd & Co
James Todd & Co have been providing accounting services for more than 30 years across Chichester, Fareham, and Portsmouth for businesses across the South East. Their clients trust them to provide bookkeeping, financial auditing and compliance, management accounting and financial advisory services.
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