IR35: Are you a disguised employee?14 Feb 2014
The IR35 legislation was put in place in 2006, to determine whether or not (from a tax perspective) a contractor is in fact an employee.
But curiously, if the result of the IR35 assessment is that a given contractor is effectively an employee for tax purposes, this provides them with none of the legal rights enjoyed but typical salaried staff.
And that really is the worst of both worlds, so it’s important to make sure that you don’t fall foul of the somewhat complex rules surrounding the IR35 legislation.
When does IR35 apply?
IR35 comes into play on any business arrangement where a person (referred to as a client) uses the services of another individual (referred to as a contractor) by involving an intermediary (a sole trader or a limited company) and that if, had it not been for the existence of the intermediary, the contractor would have been taken on as an employee of the company.
You should note that IR35 applies to anyone operating through an intermediary regardless of what the intermediary is (Ltd Company or Partnership) and the line of work.
This question is particularly pertinent in the IT industry where this situation arises regularly. If an IT professional is self employed and their services are taken on by a large business they may only have the resources to service that one client so IR35 helps HMRC decide if this worker should be treated as an employee with regards to tax or as a Ltd Company.
A term often applied to these workers is “disguised employee”.
What does IR35 do?
IR35 legislation is in place to identify that if the intermediary did not exist, the relationship between the client and the worker would have been one of employment.
IR35 rules apply when terms are given for the provision of the employee constituting employment with the client. This is call “relevant engagement”
IR35 only dictates how the worker is then taxed. The legislation does not reclassify the worker as an employee in a legal sense.
HMRC has produced a manual as a solution to this to give guidance to contractors as well as a list of factors which would suggest that a worker was in fact an employee not a contractor.
If a worker is deemed to be “an employee” HMRC will use a salary calculator to determine what is to be taxed under NI contributions and PAYE.
This means that all earnings, except for a small list of deductions like 5% for company running costs) will be taxed as a salary.