You may have come across the IR35 in the press or heard the recent hype in the UK about it. So, here’s what the IR35 means in a nutshell…
What is IR35?
‘IR35 is a word used to describe two sets of tax legislation that are designed to combat tax avoidance by workers, and the firms hiring them, who are supplying their services to clients via an intermediary, such as a limited company, but who would be an employee if the intermediary was not used.’ –contractor calculator.
There are two types of contractors.
Contractors are freelance employees who are not employed as “employees” but rather as “freelance” or “contractor” by a company. An individual will be aware of their employment basis as stipulated in their contract of employment.
The difference between ‘contract workers’ (or ‘freelance workers’) is how they pay tax.
There are several ways to do this:
A. Work under an umbrella company who calculate your tax for you.
Umbrella companies employ workers who are on fixed term contract assignments. Essentially, they are intermediaries between yourself – a contractor – and your end client or agency. Your agency (employer) pays the umbrella company, who then pay you, the contract worker, through PAYE – as if you were a full-time employee. This means you needn’t worry further.
B. Set yourself up as a sole trader. This means you work for yourself, can hire others and you are responsible for paying your own tax on your earnings.
Gov.uk advice: click here.
C. Register a limited company with companies house. A limited company is a company ‘limited by shares’ or ‘limited by guarantee’. (Gov UK)
This mean that you own the company and work for the company.
Gov.uk advice: click here.
In relation to the IR35 it is the latter being scrapped with regards to contractors. This happened for the public sector last year and is now being addressed for the private sector.
Dividend – a sum of money paid regularly (typically annually) by a company to its shareholders out of its profits (or reserves).
So why is the latter being scrapped?
There are loopholes and HMRC don’t like it.
Here’s a simple example:
If you earn £70k and are registered as option A or B then you would take home £49k after tax.
Likewise if you have a limited company but you’re not drawing dividends or expenses then you’re likely ok because you’re operating your company as a would be sole trader or freelancer with an umbrella company. The only difference being you’re paying your own tax (acting as an umbrella co. yourself.)
However if you own a limited company and you pay yourself indirectly via dividends then you likely pay considerably less tax and this is what HMRC don’t like.
‘Currently, an individual with an income of £50,000 who works through their own company, but doesn’t follow the rules, will contribute around £6,000 less (through tax, NI and employer’s NICs) than somebody doing a very similar job as an employee. This includes employer NICs contributions of around £5,000.’ – Personnel Today.
Calculating your tax
Calculating tax isn’t straightforward because:
- If you don’t draw dividends and only pay yourself a salary – there would be no implications (same as umbrella co.)
- Depends on the type of contract from your client
- Taking into account pension, expenses, money being paid back into the ltd co and amount of dividends if any
One of the best indicators is if you’re hired on a daily, weekly or monthly salary and have to work the same hours as employees (same location etc) then you likely do fall inside the IR35 if you’ve got a Ltd co.
In order to calculate your tax you can use this handy tool.
You can check your employment status for paying tax here.
So why do people who own limited companies pay themselves in dividends and not as employees?
The answer to this is simple: they pay less tax when they do so. However it’s not all sunshine in the contractor’s world.
Here are some pros and corresponding cons of being a contractor…
Pros of being a contractor and paying yourself in dividends
*Independence of choosing which contracts you want
*You earn more money while you are working
*You pay less tax
*Ability to take a sabbatical or few months off without affecting your CV
Cons of being a contractor and paying yourself in dividends
*Having to go through an interview process every few months when the contract ends to find a new job. Basically looking for a new job every few months.
*No paid holiday
*You are responsible for paying your own tax
*You won’t be paid while on a sabbatical, and your job will not be kept open for you
*Hiring company can tell you not to come in with little or no notice, without pay
*Very short notice period in some cases, one day
*You have to fill in all of your paperwork yourself and file all tax
*You have to file with company house