Umbrella SolutionDecember 18, 2023What is IR35? Implications for Contractors and Businesses

IR35 is a critical regulation that significantly impacts contractors and the companies they work with within the evolving landscape of UK taxation and employment laws. 

IR35, implemented in the UK in 2000, is a tax regulation designed to address tax avoidance practices among workers and contractors utilizing intermediaries like limited companies or partnerships to provide their services.

The legislation ensures that individuals or contractors pay the same tax and National Insurance contributions (NICs) as full-time employees.

Understanding IR35 is not just about compliance; it’s about adapting to a changing workforce environment to benefit contractors and companies. In this blog, we aim to demystify IR35, shedding light on its implications for contractors and the payroll processing challenges it presents for businesses.

IR35, also known as the off-payroll working rules, is a set of tax laws in the United Kingdom. It was established to combat tax avoidance by workers or contractors offering their services to clients via intermediary companies like umbrella firms. 

IR35 aims to establish parity in tax and National Insurance contributions between workers who, if engaged directly by the client, would be classified as employees, and those who operate through intermediaries.

The rules apply to all sectors and industries where workers provide services through intermediaries, including IT, engineering, healthcare, and finance.

Whether a contract falls inside IR35 or outside IR35 depends on several factors. An “inside IR35” status suggests employment, requiring tax and National Insurance to be deducted at the source by the client or umbrella company. Conversely, “outside IR35” indicates self-employment, allowing the contractor to pay themselves through dividends, often resulting in lower tax liabilities.

In April 2021, significant changes were made to IR35 legislation by the UK government, which shifted the responsibility for determining IR35 status from the worker or contractor to the end client. This means that if a worker provides their services through an intermediary, the end client must determine whether the worker or contractor would be considered an employee if they offered their services directly.

If the end client determines that the worker or contractor is under IR35, they must deduct tax and NICs from the worker’s fees. This puts the burden of compliance on the end client rather than the worker. However, a tie-up with the umbrella company will make things easier for the client as their compliance and payment are handled by the umbrella company.

The impact of IR35, a tax legislation in the United Kingdom, primarily affects individuals and companies operating in the UK’s gig economy and contract work sectors. Specifically, it targets individuals who provide services through intermediaries like personal service companies (PSCs) and affects companies that engage such workers.

IR35 determines whether these workers should be classified as employees for tax purposes, potentially leading to higher tax liabilities and reduced flexibility for contractors.

While IR35 is a UK-specific tax regulation, it can affect non-UK companies. Suppose a non-UK company engages UK-based contractors or operates within the UK. In that case, it may need to comply with certain aspects of IR35, such as making determinations on the employment status of contractors. This means that non-UK companies should be aware of IR35’s rules if they have a presence or conduct business in the UK.

Unlike the UK’s IR35, there is no direct equivalent tax legislation in the United States. However, the US has its regulations and tests to determine worker classification, such as the IRS guidelines for distinguishing between employees and independent contractors. While there’s no “IR35” in the US, the principles of proper worker classification are similar in both countries, focusing on factors like control, independence, and financial arrangements.

Therefore, US companies engaging freelancers and contractors should know these guidelines to avoid potential misclassification issues and tax liabilities.

Umbrella companies can provide various services to help contractors navigate IR35 and ensure compliance with the legislation. For example, they can offer advice on IR35 status and help contractors determine whether the bill catches them.

They can also provide support with invoicing and payment processing, ensuring contractors are paid correctly and deducted the correct tax and NICs. Umbrella companies can also offer a range of benefits to contractors, such as holiday pay, sick pay, and pension contributions, which can help offset the additional costs associated with IR35.

IR35 legislation, also known as the “off-payroll working rules,” is a set of tax regulations in the United Kingdom that determine the employment status of contractors and freelancers. It is designed to prevent tax evasion by individuals who work as contractors but should be classified as employees for tax purposes. In this article, we’ll explore what it means to be subject to IR35 legislation, whether a contractor inside IR35 becomes a full employee, and what it entails to be termed a “deemed employee.”

Being subject to IR35 legislation means that your work arrangement as a contractor or freelancer is under scrutiny to determine whether you should be classified as an employee for tax purposes. IR35 focuses on the relationship between the contractor and the client to assess whether it is a genuine self-employment arrangement or a disguised employment relationship.

Factors that are considered when determining IR35 status include:

• Control: The level of control the client has over how, when, and where the contractor works.
• Substitution: Whether the contractor can send a substitute to do the work on their behalf.
• Mutuality of Obligation: Whether the client is obliged to provide work, and the contractor is obliged to accept it.
• Financial Risk: Whether the contractor bears financial risks, such as the cost of mistakes and liability insurance.
• Integration: Whether the contractor is integrated into the client’s business like an employee.

If a contractor is found to be inside IR35, it means that, for tax purposes, they are considered an employee of the client rather than a self-employed individual. However, this does not necessarily mean that the contractor becomes a full-time employee with all the associated benefits.

Instead, the contractor may receive payments through the PAYE (Pay As You Earn) system, with income tax and National Insurance contributions deducted at source, similar to how they would be for regular employees. However, the contractor typically does not receive employment benefits such as paid leave, pensions, or employee perks.

Note: It’s essential to note that the contractor’s legal rights and employment status beyond tax may still depend on their contractual agreement with the client.

Being termed a “deemed employee” is another way of describing a contractor who falls within IR35. It signifies that, according to HMRC (Her Majesty’s Revenue and Customs) and the IR35 assessment, the contractor’s working arrangement with the client resembles that of an employee in terms of taxation.

In summary, IR35 legislation can have a significant impact on how contractors and freelancers are taxed in the UK. Contractors inside IR35 are subject to tax deductions at source but may not receive full employment benefits. Being termed a “deemed employee” simply refers to a contractor’s status within IR35 regulations. It’s crucial for both contractors and clients to understand these rules and ensure compliance to avoid potential tax penalties.

Pamgro is an umbrella company offering contractors and clients PEO and EOR services. They help contractors navigate the complexities of IR35 and ensure compliance with the legislation. With their EOR service, contractors become employees of Pamgro, and the company takes on the responsibility of determining their IR35 status. This frees contractors to focus on their work without worrying about administrative tasks. This gives contractors peace of mind, knowing they fully comply with the legislation and receive the correct pay and benefits.

Overall, Pamgro’s customer-centric approach to IR35 compliance helps contractors navigate the bill’s complexities and ensures full compliance with the rules. 

In conclusion, IR35 can be a complex and challenging issue for contractors, but with the proper support, it doesn’t have to be. By partnering with a reputable umbrella company like PamGro, contractors can navigate the complexities of IR35 and ensure that they remain compliant with all relevant tax legislation.

Whether inside IR35 or outside IR35, PamGro can help you maximize your earnings, minimize your tax liability, and enjoy the benefits of being a contractor. Get in touch with our team to know how we can assist you.