What is IR35?

IR35 rules were introduced by HMRC to close a loophole allowing ‘disguised employees’ to slip through the tax-paying net. The initiative is part of broader efforts to tackle the problem of tax avoidance.

These regulations help identify somebody’s employment status for tax purposes so that businesses, freelancers and contractors are all paying the right amount of tax and contributions.

Fun fact: The term ‘IR35’ comes from a combination of Inland Revenue (IR – now HMRC) and Section 35 of the Finance Act 2000, which is responsible for the legislation.

Who qualifies as a disguised employee?

A disguised employee is a contractor who has been hired on a self-employed basis, but the nature of the working arrangement is actually more like permanent employment.

The reason this happens is because employers hire contractors and ask them to work like permanent employees, but pay them as self-employed professionals and keep them ‘off-payroll’.

This means the employer gets to avoid paying National Insurance and other contributions (such as into a workplace pension scheme) and doesn’t have to provide the contractor with any other employee benefits.

The mutual benefit for the contractor is that they can create a limited company and work through that to pay themselves in a more tax efficient way.

Non-compliance can sometimes be the result of a genuine lack of awareness, but the IR35 rules are designed to penalise failure to comply regardless of the reason.

What does it mean to be ‘inside IR35’?

Before a contractor can establish whether or not they are within IR35, it’s important to understand what it actually means to be ‘inside IR35’.

Someone working inside IR35 has basically triggered the rules by working for an employer as if they were self-employed.

What happens if a contract is inside IR35 rules?

A contract falling within IR35 means that the client must add their contractor to their payroll, and pay them through PAYE as if they were any other employee.

Who decides if I’m inside IR35?

You might think that it’s up to you as the contractor to decide, but it’s actually the client’s responsibility to work out your IR35 status unless your client has:

• An annual turnover which is more than £10.2 million
• A balance sheet total more than £5.1 million
• More than 50 employees (on average) during an accounting year

For small private companies, the contractor is still the one responsible for determining their own employment status for tax purposes under IR35.

Key indicators that a contractor should be considered as being inside IR35 include:

• There’s an obligation for the client to provide you with ongoing work and an obligation for you to do it
• You’re a valuable part of the permanent team and you can’t be easily replaced within the role without recruitment efforts
• You aren’t invoicing the client directly to get paid for your services
• The client has control over things like where you work, your working hours and your time off
• You aren’t in charge of your own insurance policies (such as Public Liability and Professional Indemnity)

Whether you’re a contractor or end-hirer, you can use HMRC’s handy online employment status tool to check where somebody stands under IR35. You can also challenge the decision with your client or escalate it to HMRC’s Alternative Dispute Service if needed.

IR35 non-compliance penalties

If HMRC runs an investigation and the end-hirer has not declared applicable contractors inside IR35, they can be liable to pay all the unpaid tax and the outstanding National Insurance Contributions.

Further financial penalties will also be applied on top of this according to the extent of non-compliant activity. The rates of penalty can be broken down into three categories:

• An additional 30% of the unpaid tax: If the end-hirer wasn’t aware that they were in the wrong but HMRC still deems them careless for the error regardless
• An additional 70% of the unpaid tax: If the investigation reveals that the end-hirer was aware of the mistake they were making and chose to deliberately not comply.
• An additional 100% of the unpaid tax: Should the investigation show that the end-hirer actively concealed the employment status of the contractor and therefore evaded paying the necessary tax.

If the investigation is extensive or lengthy, there are also pretty hefty legal costs to consider as part of the non-compliance consequences.

IR35 and the Construction Industry Scheme (CIS)

It’s important to note that IR35 is different from the Construction Industry Scheme (CIS), which only applies to self-employed contractors working within the construction industry.

If you operate in the construction industry, it’s equally important to ensure that you’re up to speed with the rules and responsibilities for contractors and subcontractors under CIS too.

That said, while IR35 and CIS are separate tax schemes, they can sometimes overlap for contractors in the construction industry. Contractors who fall within IR35, for instance, may also be subject to CIS if they are subcontractors working for another contractor in the construction sector.

We promise it’s not as complicated as it sounds, but if you are feeling stuck, speak to your accountant who will be able to steer you in the right direction.

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The post Am I Inside IR35? appeared first on The Cheap Accountants.

Rather than one single employer taking on a variety of staff, there’s normally an overall project manager who takes on contractors. In turn, they’ll often use subcontractors to help deliver the work they’re contracted to do.

This hierarchy means that contractors and subcontractors often have different responsibilities; both on site, and in terms of reporting and paying tax.

What’s the difference between contractors and subcontractors?

As the name suggests, a contractor is a person or business who carries out work for an organisation without being employed by them. This is normally for a particular project (known as a contract), on a temporary basis and for a specified length of time, rather than on a permanent basis as an employee.

A subcontractor is similar, in that they also work as an independent person or business, rather than as an employee of the contractor. A contractor will often hire in a subcontractor to help them fulfil the terms of a particular contract that they’re working on. For example, if they need more people power, or a particular skill or trade.

Contractors, subcontractors, and tax

Contractual and sub contractual work is most commonly found in trades such as electrics, plumbing, decorating, and gardening. It can also be found in creative capacities such as photography, videography, graphic design, and copywriting.

Where the latter is concerned, contractors and subcontractors are generally responsible for managing their own tax payments and submitting their own Self Assessment return.

More specifically where construction is concerned though, something called the Construction Industry Scheme (CIS) comes into play.

What is the Construction Industry Scheme?

The Construction Industry Scheme (CIS) is an initiative which deals with the way subcontractors pay tax. The scheme encompasses the majority of construction workers involved in site preparation, decorating, and refurbishment.

However, it doesn’t cover some related jobs such as carpeting, material delivery, managing site facilitates (e.g., an on-site canteen), scaffolding hire, architecture, or surveying.

It covers mainstream contractors who fall under the criteria of builders, property developers, labour agencies and gangmasters. In some circumstances, it might also cover housing associations, arm’s length management organisations (ALMOs), local authorities and government departments.

How does CIS work?

Under CIS, a contractor deducts money from a sub contractor’s payment, and then passes this onto HMRC towards what the subcontractor pays in tax and National Insurance. It’s a bit like the way that an employer deducts tax and NI from an employee’s wages before paying them.

These CIS payments are due to HMRC by the 22nd of every month (or by the 19th if you’re paying by post) and there are late payment penalties of up to £3,000 if they go overdue.

Before all of this can happen though, the contractor will need to register for the scheme.

You’ll be required to register under CIS as a contractor if:

• You pay subcontractors to carry out construction-based work.
• Your business doesn’t fall under the category of construction work, but you’ve spent more than £3 million on construction in the 12 months since making your first subcontractor payment.

If you meet these criteria, there are specific regulations that you must adhere to:

• You’ll need to register for the scheme before you make your first subcontractor payment.
• You must make sure that you’re right to use this person as a subcontractor, rather than as an employee. Making this mistake can come with a penalty (under disguised employment rules).
• Establish whether or not the subcontractor is registered under the CIS (known as verifying a subcontractor).
• Remember to file monthly returns and maintain comprehensive CIS records. Again, this can incur a penalty from HMRC if you fail to do so. Even if you haven’t made any subcontractor payments that month, you must still send your CIS return to HMRC!

You’ll need to tell HMRC the gross pay of each subcontractor, and about any deductions that you make (and keep this information for a minimum of 3 years).

Where do subcontractors stand on tax and CIS?

So, we know how the scheme works for contractors, but what about from the perspective of a self-employed subcontractor?

It’s worth noting here that subcontractors aren’t legally required to register for the scheme. However, should they choose not to, their deductions will be calculated at a higher rate than those who are registered.

When you start working with a new contractor, they will ask for your Unique Taxpayer Reference (UTR) number. This will then allow them to inform HMRC that they plan to take deductions from you. Using your UTR, HMRC can then let the contractor know what rate of deduction to apply to your payments.

The rate of tax that a contractor deducts from a subcontractor’s pay depends on whether or not they’re registered under CIS:

• Registered: tax deduction of 20%
• Not registered: tax deduction of 30%

The good news is that subcontractors who pay the 30% rate are usually able to reclaim the difference between that and what they would have paid at the 20% rate, once they submit their Self Assessment tax return.

It’s one of the reasons why getting your tax return in earlier is particularly important for subcontractors: the sooner you submit, the sooner you get your rebate!

Need more help with your contractor accounting? Get an instant quote for contractor accounting services, or ask a tax question for free.

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