Tax calculator

Tax calculators > IR35 Calculator > IR35 information


IR35 Information


IR35 Philosophy
Does IR35 affect you?
Do you fall under the IR35 rules?
Standard contracts through agencies?
What about company expenses?
How do I proportion existing expenses?
How much salary will I need to declare?
Should I stay contracting or go permanent?
What if I don't issue a high enough salary?
What if I fail to follow the rules
Comments & suggestions
Resources
 

The IR35 Philosophy

IR35 has been devised to tackle the avoidance of tax and national insurance contributions (NICs) through the use of intermediaries (ie. limited companies and partnerships).

Companies can be set up to provide services of a single worker to a client. Where had the worker been in direct employment, he or she would be considered as an employee.

By setting up a limited company contractors can issue low salaries paying little PAYE and NICs. Then distribute the rest of the contract earnings from company profits as personal dividend distributions. Dividends only attract income tax making it a tax efficient form of working. This follows the philosophy of working smart as well as hard. And why not !

However, the Inland Revenue will introduce the IR35 measures to even out the tax benefit of contracting in comparison to permanent employment. Whether this approach will work remains to be seen.

We analyse IR35 rules and what they mean for you.
 

Does IR35 affect you?

IR35 is intended to apply where a worker supplies his or her services to a client through an intermediary such as a service company or a partnership.

The central question at hand being: – would the worker be considered as an employee of the client if engaged directly?

If the answer is yes, then you will fall under the IR35 rules
 

How does IR35 affect you?

If you fall under the rules you will no longer be able to declare yourself a low salary and distribute the rest as dividends from your company’s net profits. Also restrictions will apply as to how much you can claim as deduction for expenses.

Before we go into these restrictions we need to establish whether you fall under the IR35 rules in the first instance
 

Do you fall under the IR35 rules?

A two-tier approach will be taken to establishing this. The following is taken from the Inland Revenues guidance provided in February 2000.

[A] Establish the facts - the terms and conditions of engagement

The contract will usually reflect the terms and conditions that would have applied as an employee. This contract may be written, oral or implied (or a combination of the three).

By reviewing the contract and then the situation that the contractor is working in, it will be possible to establish the employment status. We look in more detail into this issue – to be or not to be an employee?

Establishing status of Employment

There is no statutory definition of "employment". The approach in the past to identify certain factors that determine the difference between a contract of service (employment) and a contract for services (self-employed). These are commonly referred to as the "badges of trade".

The following factors will need to be considered:
  1. Control
  2. The right to get a substitute
  3. Provision of equipment
  4. Financial Risk?
  5. Basis of Payment
  6. Opportunity to profit from sound management
  7. Part and parcel of the organization?
  8. Right to Dismiss
  9. Employee Benefits
  10. Length of engagement
  11. Personal factors
  12. Intention
    1. Control

      2. A worker will not be an employee unless there is a right to exercise control over the worker. Where the employer can exercise "what" work is done and "how" this is done points towards employment. On the other hand consultants tend to be in full control of, and power of, their actions in achieving the contractual agreement’s objectives.

    2. Right to get a substitute

      3. If the contractor has the freedom to choose whether to carry out the task themselves or employ another individual in their place points to self-employment

    3. Provision of equipment

      4. If the contractor generally provides all the equipment that is needed to complete the task - this points to self-employment.

      Where a contractor is provided with office space and computer equipment - this points to employment. The fact that the contractor may decide to occasionally carry out some work from home does not affect the prior fact

    4. Financial Risk

      5. In the situation were the contractor risks his or her own money (eg. buying assets for the job) and bearing other running costs such as overheads and materials - points towards self-employment. There needs to be a real financial risk, ie. taking on a fixed fee contract and running over budget on the time spent leading to a potential loss.

    5. Basis of Payment

      6. Employees get paid a wage or salary by week or by month and can qualify for overtime, bonuses and profit share. Contractors tend to get paid by the piece (delivery of project or according to amount of time worked). Either way, this factor will be taken into account but is attends to be a weak factor in relation to the rest, when distinguishing the employment.

    6. Opportunity to profit from sound management

      7. Where the profit or loss of the contract depends on ability to control overheads and organise the efficiency of the operation – points towards self-employment

    7. Part and Parcel of the organisation?

      8. Where the contractor becomes an integral part of the organization (eg. management of clients staff) this points towards employment

    8. Right to Dismissal

      9. A contract of employment usually has a notice period specified, whilst for an independent contractor the termination comes on completion of the task.

    9. Employee Benefits

      10. Employees are entitled to sick pay , holiday pay, pensions. Absence of such features do not necessarily point to self employment on short contracts where this would not have applied in any case.

    10. Length of engagement

      11. In general, the longer the regular working engagement, for the same client, the greater the indicator of employment.

    11. Personnel factors

      12. Skilled workers who have a business approach to obtaining and moving on to new contracts points to self employment.

    12. Intention

      The reality of the       relationship is important. If all other factors are neutral the intention of the parties will be taken aboard as the decisive factor.

An overview of existing rules determine the boundary between employment and self-employment is available in the Inland Revenue leaflet IR56. Press here to view in PDF format IR56 (PDF)

Q. As all the above factors are inter-related and sometimes can conflict with each other, how do you integrate all the factors to provide you with an answer to employment status ?

A. You cannot have a checklist and assign marks to each question to obtain an answer. This is strictly against the recommended Inland Revenue approach. You need to consider the overall situation as described below.

[B] Step back and consider the whole picture

Having established the facts and analysed the factors, it is a matter of evaluating the overall position, which in different situations means that the differing factors will carry different weightings and importance. You will need to step back and look at the picture as a whole.

This makes the whole process of distinguishing the employment status is open to judgment and opinion rather than a science.

To overcome this problem you will need to contact your local tax office and ask for an official written decision to be provided in your specific situation.

You will need to provide the relevant contract setting out all the terms and conditions of the engagement, together with details of any facts considered relevant to the status of the position.

Accountants with specialist knowledge are also offering advice and consultancy on the issue. If you employ an accountant contact them for advice.

If you do not have an accountant at the moment click to view from the recommended list of accountants that provide a service for contractors and IR35 issues.
 

What about standard contracts through Agencies?

If you are a contractor who obtains contracts through agencies and sign a standard agency contract the Inland Revenue have specified that it will treat any engagement of more than one month as meeting the definition of employment!

This is unless you can demonstrate a clear history of work including engagements that have the characteristics of self-employment. Cases of contracts of less than one month, and cases where there is a pattern of work, will need to be looked at on a case by case basis.

That’s a lot of paperwork for you and the government !

From this point on, we will assume that you fall under the IR35 rules to evaluate its affect on your net income.
 

What about company expenses?

Restrictions will be placed as to the amount of company expenses you can deduct from profits are as follows:

Standard expenses available to employees

These are expenses that are eligible to an employee under the normal rules (S198 ICTA 1998). These are qualifying travel expenses and other expenses expended wholly, exclusively and necessarily in the performance of duties of employment. Guidelines on expense rules can be found in Inland Revenue booklets 480 & 490

Employer pension contributions made to an approved pension scheme

A further 5% of the gross annual contract value (excl VAT) to cover the running costs of the company

What will be left are your total funds for payment of employers NI and Salary. An example is provided later on.
 

How do I proportion existing expenses?

Under the proposed restrictions when deducting expenses you need to consider the most tax efficient deductions. The 5% restriction could mean that you may find yourself in the position of not being able to claim all the expenditure that you are used to putting through the company.

The general approach would be to deduct expenses that are 100% tax deductible and have a VAT element so as to gain the most out of your expense allowance.

The following guideline has been prepared for your convenience:

DEDUCTIONS

  1. Business Travel
  2. Business Insurance Premiums
  3. Pensions
  4. Benefits in Kind – eg. Medical
  5. General Expenses at 5% limit of annual contract value:
   
VAT payable
Claimable
A:
 Accountancy
Yes
100%
Consumables
Yes
100%
Stationary
Yes
100%
B:
 Fixed Assets
Yes
40%
C:
 Other Expenses:
Books
No
100%
Postage
No
100%
Companies House Return
No
100%
 
 

How much salary will I need to declare?

You will need to issue yourself a salary taking your contract value less all the tax deductible expenses and then deduct a proportion for Employers National Insurance. Employers NI is payable at 12.2% of the Salary.

So, Salary * 1.122 = Salary (incl. Employers NI) = Funds for payment

Therefore, Salary = Funds for Payment/1.122 or Funds for Payment * 0.89

Example:

  Annual Contract   50,000
  Travel 1,000  
  Pension 3,000  
  Expenses (5% restriction) 2,500  
  Total   (6,500)
  Funds for Payment (FFP)  

43,400
  Less:    
  - Salary (FFP * 0.89)* 38,626  
  - Employers NI ((Salary-4332)*0.122) 4,712  
      (43,338)
  Taxable Profit  

62


* our IR35 calculator uses a more complex and accurate formula

The annual contract value is based on a tax year basis being income due from contract work carried out between period 6th April 2000 to 5th April 2001.
 
 

Should I stay contracting or should I go permanent ?

Use our IR35 calculator to carry out how analysis and compare the contract on the basis of:

    • Pre IR35 rules (your current position)
    • Post IR35 - falling under IR35 rules
    • A permanent employment

Use this as a guideline to analyse your future position.

Use it to provide you with a new net income position. Then try a "what if analysis" by changing the rate for contracting and employment in a post IR35 environment to find out what you need to charge in order to maintain your current rate of net income.

 
 

What happens if I don’t Issue a high enough Salary?

At the end of each tax year you will be assessed on your calculated deemed income (being the amount of salary you should have issued). If you have paid less than the required amount the Inland Revenue will deem the remaining balancing profit as deemed employment to which you will pay Tax and NI.

The onus is on you to gain a correct salary figure in the first instance. All payments for salary must be received by the 19th April each tax year. Should this not occur normal penalties will apply to late payments.
 
 

What happens if I fail to follow the rules?

Where it is discovered that you have not followed the rules the Inland Revenue will seek to collect any unpaid tax or NICs, and interest due. In addition to this, penalties may be sought in cases of negligence and fraudulent conduct.
 
 

Comments and suggestions

We hope that you have found all our information useful.

Should you have any comments and suggestions on IR35 and it’s affect on you this is your chance to make your view heard. Send an email to IR35@taxmoney.com and we will be placing your comments in our IR35 contractors feedback page.

 
 

Resources

Click Here to view the Inland Revenue’s latest information and situation on IR35.

 

 

© 2003 Taxmoney.com - All rights reserved.