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Understanding IR35 legislation

IR35 legislation was brought into force to prevent people from avoiding paying national insurance and tax by operating as limited companies in situations where they would otherwise be qualified as employees.

The rules were designed to combat the problem of ‘disguised employment’. This is where an employer would engage an employee via a limited company instead of employing him or her directly, thus avoiding the holiday entitlements, sick pay and employer’s national insurance contributions that would normally be required, while also lowering the employee’s tax bill at the same time.

Through acting as a limited company, the employee could withdraw income as a combination of dividends and salary, making it possible to avoid paying the higher rates for national insurance and income tax.

How might IR35 legislation apply to your business?

As some freelancers genuinely operate as limited companies, and the IR35 legislation depends on HM Revenue and Customs (HMRC) deciding whether any relationship between freelance worker and client is actually a disguised employer/employee relationship, then it is possible to fall foul of the regulations unintentionally. Some freelancers have even been wrongly accused of taking part in a disguised employment situation.

If HMRC subsequently decides to apply IR35 legislation, a freelancer’s income will be treated as if it is payment from employment, with income tax and national insurance contributions charged at personal, rather than corporation, tax rates.

Freelancers who run personal service companies that have a single customer for whom they work all of the time are more likely to be affected by IR35 legislation, while those who work for many different customers are less likely to be caught out. HMRC will consider a number of factors when deciding whether a freelancer is really working as employed or self-employed, but it is primarily the intent behind the relationship that matters most.

What factors affect how HMRC assesses businesses?

Some of the points that HMRC takes into account when deciding whether IR35 rules apply include whether the company and the worker have agreed that employment is part of their relationship, and whether there is an ongoing understanding that the company will continue to provide work and the employee to accept it, which are factors that could suggest employment.

There are also concerns about how much control the freelancer has. Can she or he dictate which tasks are accepted, as well as their hours worked and provide a substitute worker if desired? If so, this suggests self-employment, as is the case if all of the required equipment to do the job is provided by the freelance worker and each completed job is rewarded with a fixed payment.

If freelancers are entitled to holiday pay, sick pay and expenses from their client, this tends to indicate employment.

How to avoid being caught out by IR35 legislation

HMRC has guidance available to help businesses decide whether they risk falling foul of IR35 rules but, as this is a complex area, some self-employed individuals decide to take advice from professionals, such as accountants. This is in order to establish whether IR35 legislation might apply to their businesses and to assist them in taking the right course of action.

Posted by Louise
July 6, 2014

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