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IR35 – The Financial Implications

It has posed a serious challenge since it was introduced in 2000, and it’s been causing a great deal of concern and confusion ever since.

To put it in brief, IR35 is yet another way that HMRC targets tax avoidance in the UK. What makes IR35 unique is that it applies solely to those working through their own limited companies, specifically targeting what HMRC call ‘disguised employees’. This term refers to individuals who are working through (and being taxed through) their own limited company whilst still being treated as an employee by their client.

By operating through their own company, contractors get to benefit from a dramatically reduced tax bill through the use of dividends rather than full PAYE salary. If the contractor is not operating like a ‘genuine’ business, HMRC are keen to ensure the Treasury are not deprived of the tax they are due.

There is much information around the origins of IR35, and the potential headaches the legislation poses, but we want to address the financial implication of being caught on the wrong side of the IR35.

The simple truth is that IR35 can have massive repercussions on a contractor’s finances. For example, as a quick calculation, take a contractor earning £500 a day. If they were found to be ‘caught’ by IR35 on the past 3 years of contracting, their tax liability would be around £30,000 (plus interest). This is certainly a significant sum of money, and this doesn’t even take into consideration the potential penalties that can be applied.

Although IR35 can result in a huge pay-out to HMRC, the legislation is by no means a significant earner for the Revenue. What needs to be remembered is that IR35 has been a successful deterrent for HMRC. There are hundreds of umbrella companies in existence, where contractors will pay PAYE tax and NICs and therefore be exempt from IR35 completely. If IR35 was scrapped, there would be nothing to stop these workers from incorporating limited companies. If thousands of contractors suddenly deprived the Treasury of NICs at the rate of 26%, it would obviously create a problem, thus highlighting the importance of IR35 in the eyes of the Government.