If you’re a contractor or a company that hires contractors, it’s likely that you’ve heard about the IR35 legislation. This legislation has been covered a lot in the media lately due to the regulatory reform that is due to happen in April 2020. There are many potential effects of the changes on both companies and contractors and it’s important that you’re educated on how you may be affected. For more information on how IR35 affects companies, visit our IR35 and the public sector and IR35 and the private sector articles. Or, read on as Role Market discloses how IR35 affects contractors in particular:
Financial implications
The main risk of IR35 to contractors is the financial implications of being caught out by the legislation. If you’ve read up on IR35, you’ll know that contractors can either operate ‘inside’ or ‘outside’ the legislation. Most contractors hope to be found to be operating outside of IR35 as this means that they can continue paying tax through their limited company. Being found within IR35 means that HMRC deems you as a ‘disguised employee’ – that you are in fact an employee of your end-client, but you are operating as a sole entity for tax avoidance purposes.
Tax and National Insurance contributions
To be found within IR35 when you have been claiming that you are outside can have serious financial effects. First of all, you would be ordered to repay any tax payments or National Insurance contributions that HMRC believe you owe. HMRC can investigate contracts from up to six years ago, so this could be a lot of owed money. On top of this, they may add interest payments on your owed payments and a penalty for being non-compliant. As you can imagine, this can have serious consequences on many freelancers and contractors who are unable to provide this amount of money without sufficient notice. You can work out exactly how much you tax or National Insurance contributions you may owe with our IR35 calculator.
The risk of investigation
The risk of IR35 investigation is a worry for many contractors. There are certain factors that can increase a person’s risk of investigation, but it is fair to say that all contractors should be cautious.
Sometimes specific sectors are more prone to an investigation than others, but this list can change over time depending on the team’s focus. In the past, HMRC has focused on uncovering non-compliant doctors, teachers and decorators. In addition to this, there is the Transparent Benchmarking team who focus on building average profiles of specific contractors. If your financial reports and tax payments do not match these profiles, you might be subject to an investigation. Advanced software is another cause of an investigation as this can pick up on suspicious company profits or low tax contributions and this can lead to the HMRC team becoming interested in your activity. You may also find yourself subject to an anonymous tip-off. Perhaps you have upset a colleague or relative and this grudge may lead them to call HMRC and report your activity.
As you can see, IR35 investigations can be launched for a range of reasons. The process begins with a letter from HMRC demanding that you explain your tax and IR35 status. If they are dissatisfied with your response, you can expect a lengthy investigation to be launched which could involve a tribunal and statements requested from your clients. Not only will you face financial remunerations if you are found to be operating within IR35, but there may be other effects too. For example, many trials have been known to last months or even years and this can cause a strain on the amount of work that a contractor is able to complete – heavily affecting overall business performance.
Protection from an IR35 investigation
As you can see, an IR35 investigation is the main risk faced by a contractor regarding the legislation. But there are some actions you can take to protect yourself from an investigation.
IR35 compliance
First of all, ensure that you are well-educated on the subject. Role Market has a range of useful articles that you can read up on in order to gain a better understanding of the legislation. Being clued up on IR35 means that you can review your own contracts (past, present and future) and ensure that you’re compliant.
There are many ways to ensure that you’re IR35 compliant and the main thing to remember is that HMRC does not want to find that you have an employer-type relationship with your client. Indicators of this type of relationship include; client input into working hours; using a client’s equipment; not offering a substitute for your work if you’re unable to complete the project; the level of supervision that a client has; whether you have more than one client; and whether there is an obligation from the client to provide you with continued work. HMRC will carry out an IR35 test as such to decide whether you’re being compliant. They can usually find a lot about your employment situation from your contract so make sure that you review this regularly and check it against the IR35 rules.
IR35 insurance
Secondly, consider taking out IR35 insurance. Depending on the cover that you opt for, IR35 insurance can provide you with unbeatable protection. Many policies offer legal representation. This means that, as soon as you receive the initial letter from HMRC, you’ll be provided with an expert representative who will deal with your correspondence with HMRC going forwards. This is especially important at the start of an investigation as a well-thought-out response to the first letter can shut down the entire investigation. In addition to this, you will have legal representation if your case does end up in court. IR35 insurance will also cover you for any financial payments that you may be ordered to make, protecting your business from unexpected costs.
Contract reviews
Although you can review your own contract for IR35 compliance, it’s a good idea to get the opinion of an expert. Request the help of a legal advisor who can take a close look at your contracts and view them from the eyes of HMRC. They can look over any potential contracts before you sign them to avoid you becoming subject to any fines or unwanted penalties. HMRC have their own contract review team but you may be sceptical to use this body as if they find that your non-compliant, an investigation could be launched into your activity.
What about umbrella company contractors?
As another mode of protection, many contractors choose to go through a third party intermediary, such as an umbrella company. With this option, contractors will be taxed as an employee but there is minimal paperwork involved and it reduces the need for contractors to be worried about IR35 compliance. You can use the form on this page to find HMRC and IR35 compliant umbrella companies that match your needs.
The April 2020 IR35 reform
Another aspect of IR35 that is due to affect contractors is the proposed 2020 IR35 reform. Changes similar to those that are proposed for April 2020 have already occurred in the public sector. It is in April 2020 that these changes are due to be rolled out across the private sector too.
The main changes here involve tax liability. Currently, it is down to the contractor to decide on their own tax and IR35 status. However, to reduce the number of contractors that are falsely claiming that they are ‘outside’ IR35, the government is passing this responsibility over to the client. This did cause issues in the public sector as many clients were worried about the potential implications of a wrongly claimed tax status and therefore put most of their contractors within IR35. To combat this with the 2020 reform, contractors will now be given the option to appeal the decision made by the end-client – they will be provided with a limited amount of time to complete this by.
It’s clear to see that the IR35 legislation can affect contractors in a range of ways. First of all, it’s a reason for HMRC to launch an activity into a person’s company and this can lead to many unwanted fines or penalties that could be damaging to the running of a business. Second of all, contractors are affected as they must consider the ways to protect themselves from a negative investigation. This includes; taking out insurance, educating themselves on the legislation; operating through a third party; and requesting a contract review. Finally, the proposed IR35 reform in April 2020 is moving tax liability to the client, and contractors should take the opportunity to appeal if they think that they have been wrongly labelled.
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