A self-employed/freelancer’s guide to IR35
One of the biggest issues that freelancers and the self-employed face are taxes. This is because tax legislation is notoriously complicated, and unless you’ve spent a long time trying to understand it, it can be tricky trying to figure everything out at a glance.
Those who are work for a company have the benefit of their employers looking after most of their tax obligations. However, for the self-employed and freelancers, the responsibility lies with them.
There are a number of rules, regulations, and restrictions that apply, but one requirement that can often catch sole traders off guard is IR35. Whether you’ve heard of it or not, it’s important to understand IR35 because it could apply to you!
So, to help, this guide will cover the following:
- IR35: An overview
- When I need to pay IR35
- What does ‘inside’ and ‘outside’ IR35 mean?
- What is my IR35 status?
- Protecting yourself
IR35: An overview
Originally introduced in 2000 by HMRC, IR35 is a piece of legislation designed to stop tax avoidance by contracted or ‘disguised’ employees. Over the years, the legislation has been altered and changed, but the objective remains the same.
IR35 was designed to target contractual workers that provide services to a business through a Personal Service Company (PSC), also known as a limited company. If it wasn’t for the PSC, you would be considered a full-time employee.
When this occurs, this creates what HRMC refers to as a ‘disguised’ employee. This is when a freelancer, contractor, or self-employed person have all the responsibilities of a full-time employee, but they aren’t being taxed at the same rate.
In doing so, these individuals could take advantage of tax breaks they are not eligible for and will be paying less national insurance and tax.
Essentially, IR35 was designed to determine those that are genuine contractors and those that are employees for tax purposes.
In April 2021, IR35 was adjusted so that medium to large private companies and the public sector would fall under the legislation. Smaller companies differ, however, in that the contractor will need to determine their IR35 status.
For the public sector or a private company to be responsible for determining the status of their contractors, they need to meet at 2 of the following criteria:
- An annual turnover of no more than £10.2 million.
- No more than 50 employees.
- A balance sheet total of no more than £5.1 million.
Should these contractors fall under IR35, the public sector or private company will need to deduct tax and national insurance through either their internal payroll or through an umbrella company.
When do I need to pay IR35?
If you are classified as being outside IR35, this means that you will not need to make the same tax contributions as those that fall inside do. Instead, you will need to declare your earnings, dividends, and other financials through the self-assessment process of HRMC. Your tax will be calculated accordingly, and you will be instructed as to when it is due. Typically, you will need to pay your national insurance and Tax on the 31st of January following the end of your tax year.
If you fall inside IR35, you have two options for paying your tax. Given that you are regarded as having the status of an employee, you will make Pay As You Earn (PAYE) contributions which will be organised by the payroll or accounting staff of the company that you’re contracted to. You may also be required to pay what is known as a ‘deemed payment’, which can be paid in instalments or at the end of the year.
Alternatively, you or your client may decide to use an umbrella company, which will make these deductions on behalf of you or your client.
What does ‘inside’ and ‘outside’ IR35 mean?
As we’ve touched on already, those that are ‘outside’ IR35 are deemed to be genuine contractors. Those that are deemed ‘inside’ are viewed more as employees.
How this is determined depends on a number of factors, but the main criteria used by HRMC are:
- Supervision, direction, and control
- Mutuality of obligation
These are used to determine the nature of your contract, how you are paid, how you go about performing your work, and what happens if you can’t perform your work or fail to meet expectations.
HRMC tend to be stricter on those that fall outside of IR35, as they aren’t always able to get the same level of contributions. If you have a preference of whether you’d like to fall inside or outside of IR35, it’s important to familiarise yourself with the criteria as much as possible so you can maintain the status of your choosing.
What is my IR35 status?
Determining your own status can be tricky, but there are a number of methods that you can use. For starters, there are several online calculators, including this one offered by HRMC.
It’s important to note that these tend to act as more of a guide, and aren’t always definitive. They are a good place to start though.
Asking some of the following questions can also help to give you some clarity:
- Do you receive any benefits such as paid sick leave?
- Do you need equipment provided by your client to complete your work or do you provide your own?
- Do you work for multiple clients or just one?
- Are you responsible for your insurance, branding, marketing, and workspace?
- Is your client obliged to pay you regardless if you haven’t completed any work?
If you answered ‘no’ to most or all of these questions it’s likely you fall outside of IR35, and if you answered ‘yes’ to most or all, the opposite is true. Keep in mind, this is not definitive. It is ultimately up to HRMC to determine your status, based on the proof that you provide.
Your status can change, based on different contracts, so be sure to read any contracts to ensure that you maintain your status.
As we mentioned earlier, one of the factors that will determine your status is your insurance – mainly, if you insure yourself or that you are covered by your client. Should you be investigated by HRMC, it will likely be a lengthy, and expensive process that could leave you with large expenses to cover.
Furthermore, when working for yourself, you may enter into a dispute with a client that could lead to similar legal costs.
Instead of being vulnerable, and hoping that you avoid these unfortunate circumstances, why not protect yourself and the business you’ve worked so hard to create? Legal expenses insurance can help you to stay afloat should you need legal advice. Plus, business-related insurance can often be deducted from tax! Peace of mind and savings equals a win-win for your business!