IR35 (Part1)

IR35 is the United Kingdom's anti-avoidance tax legislation, the intermediaries legislation contained in Chapter 8 of the Income Tax (Earnings and Pensions) Act 2003. The legislation is designed to tax 'disguised' employment at a rate similar to employment. In this context, "disguised employees" means workers who receive payments from a client via an intermediary, i.e. their own limited company, and whose relationship with their client is such that had they been paid directly they would be employees of the client.

Under Chapter 8, the limited company worker is responsible for assessing their IR35 status under the rules and paying the appropriate National Insurance and Income Tax to HMRC.

New legislation was introduced on 6 April 2017 (Chapter 10 Income Tax (Earnings & Pensions) Act 2003) to make public sector organizations responsible for assessing whether an individual providing services for their organization on a contract basis fell under IR35 rules, and for paying the National Insurance and Income tax to HMRC where relevant.

These rules (referred to as the off-payroll working rules) were extended to apply to private sector businesses that were classed as medium or large per the Companies Act 2006 as of 6 April 2021. This led to some lorry drivers deciding to retire and thus contributed to the shortfall of lorry drivers in the UK.

In the September 2022 United Kingdom mini-budget it was announced that the 2017 and 2021 reforms to IR35 would be repealed, at a cost of £6.19 billion over 5 years.

IR35 and working as a contractor

IR35 rules are closely wedded to contracting work. If you work as a contractor through a limited company, you can pay corporation tax at 19% on profits under £50,000 . You can also claim business costs against your tax bill and avoid making National Insurance Contributions (NIC) by paying yourself through dividends.

As a result, working as a contractor is often a more tax-efficient set-up than working via an umbrella company or as an employee of a company. Many contractors who are, in reality, operating in the same way as employees are intentionally or unintentionally gaining a tax advantage over others working in the same way as them.

The government has said that it wants to use IR35 to remove this unfair advantage, and at the same time increase its overall tax revenue. That means IR35 could have significant consequences for limited company owners.

Following reforms in April 2021 , it is now the client’s responsibility to determine the IR35 status of contractors in both the public and private sectors. The exceptions are small businesses in the private sector. In these cases, contractors are responsible for working out their IR35 tax status.

What does inside IR35 mean?

To be operating ‘inside IR35’ means that, under the IR35 legislation, you must pay the same tax as an employee. This could also mean that you are entitled to additional rights as an employee or worker (e.g. minimum wage, maternity pay, protection from discrimination).

If you’re found to be working inside IR35, you will usually have to pay a ‘deemed payment’ of income tax at the end of the tax year to account for any tax deductions or NIC that an employee would have paid.

What does outside IR35 mean?

To be operating ‘outside IR35’ means that the IR35 legislation does not prevent you from paying tax on the private contractor basis described above. This means you can pay yourself a salary and withdraw further income as dividends (which are not subject to NIC). Meanwhile, your limited company can pay tax at the 19% corporate rate if your profits are under £50,000.

Things that indicate you are outside IR35 and are operating like a business include having your own business insurance, marketing yourself via a professional website, owning your own equipment and working for multiple clients.

As a contractor, you should consider getting detailed advice on your IR35 status. An IR35 assessment could review both your service contracts and day-to-day working practices.

What do the latest IR35 changes mean?

April 2021 saw a major shake-up of the IR35 rules, which remains in place today. The aim was to align different processes in the public and private sectors.

These IR35 changes were originally expected to be implemented in April 2020. However, due to the Covid-19 pandemic, the government announced an IR35 delay. Instead, the new IR35 regulations were deferred a year, to 6 April 2021. So, what do they now mean in practice?

Key IR35 changes explained

When IR35 first came into force in 2000, each contractor was responsible for assessing their own IR35 status. It was also the individual’s limited company or agency who was responsible for accounting for any tax and National Insurance due where IR35 was applicable.

The rules then changed in 2017 for the public sector. This meant that the responsibility for ensuring IR35 was correctly implemented shifted from the contractor to the public sector body engaging them. However, responsibility remained with the contractor in the private sector.

The IR35 changes of April 2021 aimed to make things more uniform between the public and private spheres. The responsibility for setting IR35 status and paying relevant tax passed from contractors to the private sector businesses engaging them – like in the public sector. It also made the engaging businesses liable should HMRC decide a status had been incorrectly assessed.

These latest IR35 tax changes in the private sector exclude small businesses, however. So, contractors working for small business clients continue to set their own IR35 status.

The Companies Act 2006 defines a small business as a business with two or more of the following features:

  • Turnover of £10.2m or less
  • A balance sheet total of £5.1m or less
  • 50 employees or fewer

Who is liable for IR35?

Since April 2021, end clients have been responsible for determining their contractors’ IR35 status in both the public and private sectors. They must also ensure the correct income tax and NIC are paid if it’s decided the contractor is operating inside IR35.

Contractors are now only responsible for determining their own status if they operate in the private sector and work for a client that’s classed as a small business [4].

Clients send a document called the Status Determination Statement to inform contractors of their decision. If a contractor is inside IR35 and contracted directly, the client then becomes their deemed employer. This gives them responsibility for:

  • Income tax deductions
  • Employee NIC deductions
  • Payment of employer NIC
  • The Apprenticeship Levy

If a contractor is working outside IR35 and HMRC has reason to question this, it may open an IR35 enquiry. HMRC can investigate your arrangements at any time, which has the potential to be time-consuming, costly and stressful. This may include a review of tax returns from the previous year. It could also go back up to six years if careless or negligent behaviour is suspected [5].

If HMRC decides the evidence is not satisfactory, it will conduct an in-depth review of written contracts and working practices. From this, it will make a final decision on the status of the contract. Penalties can apply to both parties if HMRC ultimately decides a contractor is inside IR35.

Some goods and services are exempt from VAT. If all the goods and services you sell are exempt, your business is exempt and you will not be able to register for VAT. This means you cannot reclaim any VAT on your business purchases or expenses.

If you are VAT-registered and incur VAT on any items that will be used to make exempt supplies, you are classed as partly exempt.

Exempt goods and services

There are some goods and services on which VAT is not charged, including:

  • insurance, finance, and credit
  • education and training
  • fundraising events by charities
  • subscriptions to membership organizations
  • selling, leasing, and letting of commercial land and buildings — this exemption can be waived

These items are exempt from VAT so are not taxable. You do not include sales of exempt goods or services in your taxable turnover for VAT purposes. And if you buy exempt items, there is no VAT to reclaim.

Exempt items are different from zero-rated supplies. In both cases, VAT is not added to the selling price, but zero-rated goods or services are taxable for VAT — at 0%.

Exempt business

If you only sell or otherwise supply goods or services that are exempt from VAT then yours is an exempt business and:

  • you cannot register for VAT
  • you cannot recover any VAT you incur on your purchases or expenses

This is in contrast to where you sell or otherwise supply zero-rated goods or services. Here you can reclaim the VAT on any purchases that relate to those sales.

If you sell mainly or only zero-rated items, you can apply for an exemption from VAT registration. If you are exempt from registration you will not be able to reclaim any VAT.

Partly exempt business

Your business is partly exempt if your business has incurred VAT on purchases that relate to exempt supplies. This is known as exempt input tax.

Generally, you will not be able to reclaim exempt input tax. However, provided the amount of exempt input tax is below a certain amount, it can be recovered in full.

Non-business use in a partly exempt business

You cannot reclaim the VAT you pay on goods and services that are not for business purposes.

If your business is partly exempt and you buy goods or services that you use partly for business and partly for non-business purposes you must split the VAT accordingly. You then use your partial exemption method to work out how much of the business VAT you can reclaim.

Keeping records if your business is partly exempt

If you make both taxable and exempt supplies, you must keep a separate record of your exempt sales and details of how you’ve worked out how much VAT to reclaim.

Land and buildings

If you sell, lease or let commercial land or property, you can choose to waive the exemption and charge VAT at the standard rate. This is known as opting to tax land and buildings. VAT incurred in making taxable supplies can be reclaimed.

Acquiring or creating a capital asset

If you acquire or create an expensive capital asset you may have to use the Capital Goods Scheme to adjust how much input tax you initially reclaimed in future years. The scheme applies when your capital spending, net of VAT is:

  • £250,000 or more on land or buildings, or on building or civil engineering works
  • £50,000 or more on a single computer or piece of computer equipment
  • £50,000 or more on an aircraft, ship, boat, or another vessel

You’ll have to adjust the amount of VAT you reclaimed if your business has an asset, and the extent to which you use it to make taxable supplies (rather than exempt supplies) varies over the following 5 or 10 years (depending on the asset).

You can reclaim more if the proportion of your taxable supplies increases, but you’ll have to repay some if it decreases.

If you move your goods from Great Britain to Northern Ireland

If you move your goods from Great Britain (England, Scotland, and Wales) to Northern Ireland, you will usually be able to recover the full amount of VAT as if it had been a taxable supply.

However, if you make supplies that are exempt from VAT you may not be able to recover some or all of the VAT on goods when they are first purchased. If you then move the goods from Great Britain to Northern Ireland you will incur a VAT charge.

You may also be further restricted in what input tax you can recover. For example, if you are making exempt supplies. This will mean that you have incurred an input tax restriction twice on the same goods.

To prevent this, you should reattribute the previously unrecovered input VAT on the original purchase in Great Britain as if the goods had been used for a taxable purchase. You can do this when making your annual adjustment.

How to recover VAT on exempt supplies moved to Northern Ireland

For example, if you purchase goods that are valued at £10,000 plus VAT of £2,000. Because you are making exempt supplies, only £1,000 of the VAT is recoverable.

If you then move the goods to Northern Ireland you will be charged a VAT of £2,000. The partial exemption calculation at that time only permits £900 to be recovered.

This would mean you have paid £4,000 VAT and only claimed £1,900 as input tax.

To remedy this, you should treat the movement as if it were a fully taxable supply. This will allow you to recover the originally restricted input tax as being fully attributable to that taxable supply.

You can do this as part of your annual adjustment. The VAT may be reclaimed subject to the normal rules.

Hope the above helps when you come across a similar situation.