Is it Better to be Inside or Outside IR35?

For contractors and limited company contractors, understanding the IR35 regulations is crucial for determining their employment status and tax obligations. IR35 refers to the legislation that applies to individuals who provide services to clients through an intermediary, such as a limited company or personal service company. The regulations aim to combat tax avoidance by ensuring that individuals who would be regarded as employees for tax purposes if they were engaged directly are subject to the same income tax and national insurance contributions.

As of April 2021, changes to IR35 mean that the responsibility for determining whether IR35 applies now falls on the end client in the private sector. In the public sector, this has been the case since 2017.

There are advantages and disadvantages to being inside or outside IR35, with different implications for those operating in the private and public sectors. It is important for contractors to understand their IR35 status to ensure compliance with the regulations and optimise their financial situation.

Key Takeaways

• IR35 regulations apply to individuals who provide services to clients through an intermediary.
• Changes to IR35 in 2021 mean that the responsibility for determining IR35 status now falls on the end client in the private sector.
• The decision of whether to be inside or outside IR35 depends on various factors such as individual circumstances, working practices, and the specific industry.
• It is important to seek professional advice from an accountant or tax expert to fully understand the implications and make an informed choice.
• Contractors should carefully consider the risks and benefits associated with each status to ensure compliance with the IR35 regulations and optimise their financial situation.

Understanding IR35 and Its Implications

Private sector contractors and public sector contractors alike must understand the IR35 rules and how they affect their employment status for tax purposes. The changes to IR35 regulations that came into effect in April 2021 have had a significant impact on those operating through limited companies, and it is crucial to determine whether they are inside or outside IR35.

Employment status is a crucial factor in determining whether a contractor is regarded as an employee for tax purposes. If a contractor is deemed to be a disguised employee, they may be required to pay income tax and national insurance contributions as if they were an employee. The use of umbrella companies has become increasingly popular in recent years, but it is vital to understand the role of these companies in relation to IR35.

There is a significant difference between being inside or outside IR35. If a contractor is deemed to be working inside IR35, they will be subject to tax and national insurance contributions on their income. In contrast, if they are considered to be outside IR35, they will have greater tax benefits and can deduct business expenses from their income before paying tax and national insurance contributions.

Determining IR35 status requires a review of the contractor’s working practices and the terms of their contract. If the contract is deemed to be inside IR35, the contractor will be regarded as an employee for tax purposes and will be paid as such. In contrast, an independent IR35 contractor will be paid gross and will be responsible for managing their tax and national insurance contributions.

It is essential to review IR35 contracts regularly to ensure that they are compliant with the regulations. In doing so, contractors can mitigate the risks of being caught inside IR35 and facing hefty tax bills. It is also crucial to note that the determination of a contractor’s employment status is not solely based on their contract but also their working practices.

Overall, private sector contractors and public sector contractors must have a thorough understanding of the IR35 rules and how they affect their employment status. It is important to seek professional advice to determine whether a contractor is inside or outside IR35 and ensure compliance with the regulations.

Pros and Cons of Being Inside or Outside IR35

For limited companies, IR35 applies to the income tax and national insurance contributions paid on earnings. When working for an end client, you may fall inside or outside of IR35, which determines the amount of tax and national insurance you need to pay.

If you are ‘inside IR35’, you are regarded as an employee for tax purposes, and your national insurance contributions and income tax will be deducted at source by your end client or the agency through which you work. Umbrella companies can help manage this process on your behalf, but they will deduct their own fees.

If you are ‘outside of IR35’, you’re considered self-employed, and you’re responsible for managing your own tax and national insurance contributions. You may be subject to paye if you have other sources of income that result in you falling into the higher tax bracket. Additionally, you can deduct your tax and national insurance contributions from your earnings and pay the remainder as dividends.

Working outside of IR35 usually means that you are not entitled to certain employee benefits, such as holiday pay and sick pay, but you gain greater tax benefits and are responsible for managing your own tax affairs. However, operating through a limited company can increase tax efficiency and provide greater flexibility in providing services.

Determining whether IR35 applies to a contract is a complex process that involves reviewing your working practices, the terms of your contract, and the nature of your relationship with the end client. HMRC introduced changes to IR35 regulations in April 2021 that shifted the determination for the income tax and national insurance contributions payable onto the end client for private sector contractors, which has seen tens of thousands of contractors caught inside IR35.

Public sector contractors have been subject to these changes since 2017, where HMRC decides whether IR35 applies to a contract based on the working practices. If you are caught inside IR35, according to HMRC, you are considered to be operating as a ‘disguised employee’ and should pay yourself a salary to reflect this, otherwise, you may have to pay backdated income tax and national insurance contributions, which can run into the tens of thousands.

The decision of whether to be inside or outside IR35 depends on various factors such as individual circumstances, working practices, and the specific industry. It is important to seek professional advice from a commercial lawyer, accountant or tax expert to fully understand the implications and make an informed choice. Contractors and limited company contractors should carefully consider the risks and benefits associated with each status to ensure compliance with the IR35 regulations and optimise their financial situation.