Rolled out in 2000, HMRC introduced IR35 legislation to stop disguised employees from taking advantage of tax breaks that they shouldn’t be entitled to. IR35 has always been spoken about, but it’s been a very hot topic recently, as changes will be implemented from 6th April 2021. These are commonly referred to as changes to off-payroll in the private sector (2021). This short article will look at the difference between being inside and outside IR35 legislation.
If a contractor is deemed to be inside IR35, they’re considered to be subjected to very similar working arrangements to permanent employees. Therefore, they’re not able to pay themselves with a combination of dividends and salary through a personal service company (PSC). Instead, the fee-payer in the supply chain (often a recruitment agency or third-party payment intermediary, such as an umbrella company) will need to make the appropriate deductions to the contractor’s pay (PAYE) before passing the worker their net salary.
Workers who are inside IR35 regularly choose to use an umbrella company for their payroll, because there are no benefits to working through a limited company. Compliant umbrella companies are an efficient and reliable way to get paid, but pay retention is not as high when compared to operating through a PSC, outside IR35.
Contractors with a PSC will always try to ensure they’re working on assignments outside IR35. Why? Because it’s the most tax-efficient way to operate as a contractor.
Contractors outside IR35 will receive gross funds from the fee-payer in the supply chain. They can then take salary and dividends from their PSC in a tax-efficient manner – ensuring they legally maximise their pay retention.
Being outside IR35 means a temporary worker is genuinely self-employed and does not have access to benefits that permanent employee do, for example.
Assessing IR35 statuses
Making IR35 assessments is complex, and there are IR35 tax status specialists that can help. The three main factors that help an assessor identify a contractor’s IR35 status are:
Supervision, direction and control (SDC) – is the worker subjected to supervision, direction or control from someone when undertaking their assignment?*
Substitution – can the contractor send someone else to complete the work? A substitution clause often strengthens an outside IR35 contract.
Mutuality of Obligation (MOO) – is there an understanding that the employer will consistently provide the contractor with work, and is the contractor expected to accept it when offered?
Changes to off-payroll legislation
HMRC rolled out changes to off-payroll in the public sector in April 2017. To summarise – contractors in the public sector could no longer determine their IR35 status. Instead, this became the responsibility of the end-hirer – the client the contractor was completing work for.
Similar changes will be coming into the private sector from 6th April 2021 (off-payroll in the private sector), and contractors in the private sector cannot determine whether they’re inside or outside IR35. This will be the end-hirers responsibility – providing they’re categorised as a medium or large business in the eyes of HMRC.
Hopefully, the above has given you a fundamental insight into the difference between being inside and outside IR35 legislation. For more information, check out our IR35 page, and visit the government’s website.
*Supervision, direction and control is used as a method of identifying whether umbrella company contractors can benefit from tax relief on travel and subsistence expenses. However, it’s also useful when making IR35 assessments.