The IR35 provisions prevent avoidance of tax by providing services through a company. In essence, IR35 affects all contractors who do not meet HMRC’s definition of ‘self-employment’. This article aims to clarify some of the complications and problems associated with IR35, and guidance on calculating deems salary payment will also be outlined with an example if IR 35 applies to you.
What is IR35?
Workers normally prefer to avoid being classified as employees as the tax and national insurance burden on the self-employed is lower. However, there is risk that workers claiming to be self-employed will be classified by HMRC as employees, leading to increased taxation and liability to penalties, both for the worker and those who use their services.
If the worker sets up a company (know as a personal service company or PSC) to provide services to a client, the worker is both the owner of the company and an employee of the company. An employment relationship could not arise between the client and the worker because of the existence of the intermediary and so payments by the client were not subject to PAYE and no NICs were payable.
In addition, the worker could obtain tax advantages in extracting profits from the PSC as compared with the situation where the worker was self-employed.
In April 2000, the government introduced anti-avoidance legislation, known as IR35, with the purpose of countering this problem.
When does IR35 apply?
IR35 provisions apply where:
1. An individual (worker) performs or has an obligation to perform, services for a client and
2. The performance of those services is referable to arrangements involving an intermediary rather than referable to a contract between the client and the worker and
3. If the services were to be performed by the worker under a contract between the worker and the client, the worker would be regarded as employed by the client.
The intermediary can be:
- your own limited company
- a service or personal service company
- a partnership
If the intermediary is a company, the IR35 provisions will apply only if:
1. The worker has a material interest in the company, or
2. The payment or benefit arising from the work done for the client is received or receivable directly from the intermediary and can reasonably be taken to represent remuneration for services provided by the worker to the client.
What to do if IR35 applies?
If IR35 applies, as the director of your company or member of a partnership, you must:
- calculate the deemed employment payment and pay any tax and National Insurance contributions due, at the end of the tax year
- account for those payments correctly
- reassess the IR35 position if your contracts vary or change
- take into account the deemed employment payment when paying Corporation Tax, making distributions or operating the Construction Industry Scheme (CIS) regime
You’ll also need to report information about IR35 on your Self Assessment tax return.
Your intermediary must also operate PAYE on any salary or wages it pays to the worker during the tax year.
PENALTIES FOR NOT FOLLOWING IR35 RULES
There can be significant consequences if you, your intermediary, or client ignore IR35 legislation. Interest and penalties can be charged on any extra tax and National Insurance contributions that are owed. Penalties can be more severe if it can be proved that IR35 rules or legislation have been deliberately ignored.
Computation of deemed salary payment
A salary payment may be deemed to have been made to the worker at the end of the tax year if the IR35 provisions apply.
The following steps should be followed to compute the amount of the deemed payment:
Step 1 Take 95% of all payments and benefits received in respect of the relevant engagements by the intermediary.
Step 2 Add amounts received in respect of the relevant engagements by the worker other than from the intermediary.
Step 3 Deduct expenses met by the intermediary
Step 4 Deduct capital allowances on expenditure incurred by the intermediary
Step 5 Deduct any registered pension contributions and employer’s NICs paid by the intermediary
Step 6 Deduct amounts received by the worker from the intermediary that is chargeable as employment income but were not deducted under step 3
Step 7 Multiply the amount in step 6 by 13.8/113.8 and deduct this amount from the amount in step 6.
Step 8The result is the deemed employment income.
Effect on the company
The deemed employment income is an allowable trading expense for the personal service company and is treated as paid to the worker on the last day of the tax year. If dividends are paid out of this income, they are treated as exempt in order to avoid a double charge to tax on the same income.
Example: Personal service company
Peter offers heating and plumbing services through a company. During 2015/2016 the company received income of £50,000 in respect of relevant engagement performed by Peter. The company paid Peter a salary of £30,000 plus employer’s NIC of £1042. The company also pay £3,000 into an occupational pension scheme in respect of Peter. Peter incurred travelling expenses of £500 in respect of the relevant engagements.
The deemed employment income taxed on Peter is
Income (£50000×95%) 47500
Less: travel (500)
Employer NIC on actual salary (1042)
Less employer’s NIC on deemed payment
13.8/113.8 ×12958 (1571)
Deemed employment income 11387
IR35 is a minefield for contractors and can’t be ignored. If you have any further concerns about IR35, please call our IR35 specialists on 0161 278 2714. Our expert will help you assess whether you are contracted inside or outside of IR35.