IR35 is a UK tax legislation. It is formulated to close the loophole in the tax system, where workers could use a setup of limited company to pay less tax. If the relation between the end client and the worker is of self-employment rather than employment then IR35 does not apply. The worker should be taxed as an employee. This is referred as “deemed employee.”
Contractors using a limited company can take the majority of their earnings in the form of dividends which is taxed at a lower rate than income tax. The contractors were exploiting the tax system by creating limited companies and returning to the same role of contract relationship to benefit the tax setup of limited company. Later, Gordon Brown enforced the IR35 legislation in 2000. Since then, contractors are judged to be employees and have to pay tax the same as the regular employee. Deemed employees does not enjoy access to any benefits same as typical employees such as sick pay, holiday or company pensions.
What does Outside IR35 means?
If your contract is deemed Outside IR35, you are considered as running a business for tax purposes and are free to pay yourself in the most tax efficient way, which is typically through salary and dividends taken from your company. You are also liable to file a corporation tax which is due on any profits the company makes within one year of its year end, and tax on dividends. Contractors working as Outside IR35 should ensure their company and personal taxes are paid correctly and on time. Here, you are operating as a business, and outside of the IR35 rules.
Tax implications Outside IR35 status:
- You have the right to provide a substitute in your place
- Your company carries the financial risk and hence liable for any mistakes you make.
- The client doesn't control you. You have the freedom to work as and when possible.
- You are not “part and parcel” of the your client's organisation and hence, you don’t get to enjoy benefits as that of an employee.
- Your contract has a start and an end date.
If engaged to the medium or large private sector business from April 2020, your end client is responsible for determining your status, but if they have deemed you as ‘outside IR35’, then you will be paid your fee as normal and you will be responsible for managing your taxes as you would usually do.
Even if working outside IR35, there is chance of inquiry from HMRC. The inquiry may last for years and contractors as well as the end clients can place their foot in due to their inexperience with HMRC inspectors. There is no need to calculate deemed payment. But for the peace of mind, you can obtain CEST tool for confirmation.