Tax is for everyone, or rather paying tax is a civil duty of everyone. We often wonder what happens to the solid chunk of money we send out to the government. In simple terms, every government collects taxes from its citizens in order to be able to fulfill its responsibility of providing roads, water, sanitation facilities, healthcare facilities and the like. The taxation system of every government in terms of complexity and percentages vary from place to place. Some people often feel that snatching a huge percentage of the hard earned money as the tax is unfair. However, the truth of the matter is that the government would require millions of pounds to meet all the needs of its citizens. Since the tax is directly related to the macroeconomic environment of the country, it is inevitable. Without the income from taxation, the government may not be able to fulfill their obligations. If we see taxes as a price we pay for ourselves, for our own benefit, just like paying for a meal in restaurants, probably we can pay the tax without feeling the pinch because that is what tax is all about. But all said and done; taxes are more than just essential. It is equally important that we understand why taxes are essential and inevitable and also the different aspects of the taxation system.
If you ask any contractor about the best and worst bits of his job, it is almost sure that you will hear about IR35 legislation among the worst bits. The IR35 legislation has been the most unpopular legislation aimed at a particular sector of workers and has been a bane of contractors for a very long time. In simple terms, IR35 is United Kingdom’s anti avoidance tax legislation designed to tax disguised employment. Before IR35 was introduced, the owner of a limited company was allowed to get payment from the clients directly and to use the company revenue as any small company would, as dividends. Workers could thereby save tax by splitting the ownership of the company with family to fall into lower tax bands, to reduce the amount of tax the government rightfully deserves.
What exactly is IR35?
The IR35 legislation was introduced in April 2000. Putting in simple words, IR35 legislation was added to the statute book with the sole aim to stop contractors working as disguised employees and benefitting from the tax advantages of being a director of the limited company, like the dividend payment, reduced National Insurance contributions, and business expenditure allowances. IR35 legislation can also be thought of as a way to find out if contractors are providing professional services to any clients by means of a partnership or limited company and doing so is with the sole purpose of getting exempted from the PAYE (Pay As You Earn) tax and the NIC (National Insurance contributions). This would mean that the contractors will be saving a lot of money for themselves and the company they are working for, by opting for the normal PAYE (Pay As You Earn) tax, the NIC (National Insurance contributions), the dividends and the corporate tax of a limited company which would be significantly lower. The Contractors who fall under the category of IR35 legislation will be liable to pay Schedule E Taxation and National Insurance after limited deductions for expenses. So the IR35 legislation can also be defined as the response of the government and HMRC (Her Majesty’s Revenue and Customs) to the contractors who are none other than the employees of a particular client, who disguise themselves as contractors of the client, thereby saving a large chunk of income for themselves and the company they work for. It is essential to know if you fall under the IR35 legislation. As there are no specific rules in law to find out if you fall under the category of IR35 legislation, there are numerous business entity test to know if you are at a low, moderate or high risk of falling under the IR35 legislation. Nevertheless, being so broad in its scope and so open in its terms, many contractors get caught out by it as unfair according to them and end up paying more tax and penalties than their income. Hence it is essential to know if you fall under the IR35 legislation. However, there isn’t a straightforward key to this. Each engagement is measured upon the merits, and generally the best approach is to look at all of the relevant factors of the engagement, especially the contract under which services are provided and the actual working practices of the contractor. The main indicators of the engagement that are looked for include right of substitution, provision of equipment, business justification, mutual obligation, financial risk, the right of control and the like.
To understand the IR35 legislation further, let us consider a scenario wherein an employee of a firm gives notice or rather resigns from his position of job on a weekend and comes back on the following day as a contractor doing the exact same job he was doing when he used to be an employee, for same working hours, providing services for the same bosses, with as much involvement as before, is a very obvious example and one that would be immediately flagged by the IR35 legislation. This is an extreme hypothetical case, and the real problem begins when the line is not finely cut out. HMRC (Her Majesty’s Revenue and Customs) have become more and more vigilant, determined and ruthless in the pursuit of tax avoidance by the contractors and are obsessed in moving as many contractors to the payroll as possible. There are four core areas that is looked into, to ensure if you are working as a legitimate contractor or as a false employee and the four areas are a level of risk, responsibility, control, and liability. And of course, there are many other contributions that tie with the above four areas and check whether they apply to your dealings via your contracting company.
How do you know if you fall under the category of IR35 legislation?
To give the full name, the Inland Revenue 35 better known as IR35 is a tax legislation introduced by the HMRC (Her Majesty’s Revenue and Customs) and the government with an aim to weed out disguised employees and collect the tax that the government rightfully deserves. The problem is that the legislation does not have a proper demarcation to differentiate between people who fall under the category of IR35 legislation. However, there are four ways or features that are analysed.
- Do you have the control?: This is the very first question you should be asking yourself when it comes to the IR35 legislation. You should be able to convince the HMRC about the level of control you exert over your contractor company. This also does not have a clear cut defined line, but having an optimum level of control over the work you do is an ideal way. You should be able to decide the kind of services you perform, where you perform them, when you perform them and how you perform them. In other words, any contract between two companies should not involve one party dictating work to the other; rather it should be simply one company engaging the service of other.
- Are you vulnerable to the financial risks?: Another way to ensure that you do not fall under the IR35 legislation is to prove that you are at a potentially equal risk of financial losses as any other director of similar contracting companies. This is because it is quite obvious that you would not be faced with any potential financial risks whatsoever if you were just an employee of the company. If you are a director of the company, you will definitely be vulnerable to the financial risks.
- What are your working obligations?: According to the norms of the HMRC, the right to dismiss another one is a key in determining whether the relationship is that of an employer-employee or that of limited company-client. In other words, if you are obliged to take on every bit of work they offer or give you, then the relationship is more of an employer and employee, the IR35 legislation would be applicable.
- Does the working equipment belong to you?: Surprisingly, this is a key factor that the HMRC would be closely looking at while trying to establish the status of a contractor. The HMRC believes that the ownership of the working equipment like the laptops that are used to do the job is a key in determining the relationship between the client and the contractor. Say, if the contractor is providing the working equipment like the laptops, engineering instruments for taking readings, ladder for painting, then the contractor is at a potential financial risk, and this is something the employers hardly do. So, if an employer provides you with laptops and other similar gadgets for completing your work at hand, the HMRC probably has another reason to argue that you fall under the IR35 legislation.
- Do you enjoy any employee benefits?: If you do, you are definitely not a director and are an employee liable to pay the IR35 legislation tax. If you want to prove yourself as a legitimate director of a limited company, you should first ensure that you do not enjoy any of the employee benefits, If you slip on that, be prepared to sit down with the HMRC IR35 team soon enough.
Read More at: How Contractor found relief from HMRC determinations in IR35 case?