What does "inside IR35" mean?
In recent years, the UK government has tightened the IR35 regulations, affecting many contractors working through a personal service company, such as a limited company.
This article aims to comprehensively understand what being “inside IR35” means and its implications for contractors. We will cover essential aspects, including income tax, national insurance contributions, and the differences between public and private sector contractors.
What Does Inside IR35 Mean?
Being inside IR35 means that a contractor is deemed to be an employee for tax purposes and subsequently subject to PAYE. They will pay income tax and national insurance contributions at the same rates as a permanent employee.
This classification can significantly impact a contractor’s financial earnings and the way they manage their personal service company or limited company in the future.
Determining Employment Status
To determine if a contractor’s engagement falls inside IR35 or outside IR35, both the working practices and contractual business relationship between the contractor’s limited company and the end client will be considered.
Factors such as personal service, control, and mutuality of obligation (MOO) are considered to evaluate the contractor’s employment status.
Public vs. Private Sector
Despite IR35 being around since 2000, off-payroll rules were first implemented in 2017 in the public sector. Contractors in the public sector will already be familiar with their end client determining their employment status.
In contrast, the private sector finally joined the public sector when off-payroll reforms were rolled out in 2021 following a year’s delay due to covid 19. End clients, in most cases, in both the public and private sectors must assess and determine the contractor’s IR35 status for tax purposes via status determination statements (SDS)
Off-Payroll Working Rules
As mentioned already, the off-payroll working rules, which apply to public and private sector contractors, place the responsibility of determining IR35 status on the end client.
These rules also require the fee payer to deduct tax and national insurance contributions if the contractor is deemed to be inside IR35.
Consequences of Being Inside IR35
Contractors found inside IR35 must pay income tax and national insurance similar to permanent employees. This may result in higher tax payments and reduced net earnings compared to contractors outside IR35.
Following the off-payroll reforms, the correct tax should be deducted by your fee payer. This is usually your recruitment agency or your end client if engaged directly.
Many contractors opt to work through an umbrella company to simplify their tax and national insurance contributions. This requirement to use an umbrella company is however often driven by end clients upon determining that an engagement is inside IR35.
An umbrella company acts as the contractor’s employer and as the intermediary between the contractor and their recruitment agency or end client. They will be responsible for deducting income tax and national insurance from the contractor’s earnings. This also provides contractors with employee benefits such as holiday pay, sick pay and pension contributions etc. Your umbrella company is like any other employer and therefore subject to employment law.
Seeking Professional Advice
Determining whether a contractor falls inside or outside IR35 can be complex, particularly when considering the specific circumstances of each contract.
It is crucial for business contractors to seek specialist legal advice or consult with a professional accountant to ensure compliance with IR35 regulations.
Contractors’ Attitude Towards Working Inside IR35
Our recent survey data highlights a growing reluctance among contractors to work inside IR35. A significant 72% of contractors are now unwilling to accept inside IR35 roles, up from 55% in the previous year.
This shift can be attributed to the increased availability of outside IR35 roles and a change in attitude among end clients, who now recognize contractors’ value.
Difficulty in Filling Inside IR35 Roles
The reluctance of contractors to work inside IR35 has also affected recruiters, with 62% of them reporting difficulty in filling such roles. This figure has risen from 58% in the previous year and is even higher at 77% when the end client uses the CEST tool.
This trend aligns with contractors’ preferences, as they increasingly opt for outside IR35 roles to maximise their earnings and retain more control over their working arrangements.
Increased Rates for Inside IR35 Roles
To attract contractors to work inside IR35, many recruiters and end clients are offering higher rates for these roles. According to the survey, 73% of recruiters have increased rates for inside IR35 roles, up from 63% in the previous year.
This trend indicates that organizations pay more for the same talent, as contractors demand higher compensation for the potential financial risk associated with inside IR35 positions.
Potential Tax Liability for Contractors
The survey data also reveals that the most common daily rate for contractors is between £400 and £500, which often results in contractors increasing their prices.
Based on a worst-case scenario payment calculation, it is estimated that each contractor could carry a tax liability of roughly £30,000 annually if placed outside IR35. This figure represents a significant financial burden for organizations that engage large numbers of contractors and must manage the associated tax liabilities as fee payers.
Understanding the meaning and implications of engaging with limited company contractors either inside IR35 or outside IR35 is essential for UK businesses. This knowledge allows them to navigate the complex tax landscape, make informed decisions about their working arrangements, and ensure compliance with HMRC requirements.
By staying informed and seeking professional advice, contractors can successfully adapt to the evolving IR35 regulations and protect their financial interests ensuring they are operating legitimately.