Making the decision to “go it alone” as a contractor or self-employed professional can be both exciting and daunting. You need to set up a limited company, find work for your business and handle the day-to-day administration of the company. You also need to ensure your company complies with all relevant tax legislation for small service companies. The most important tax legislation to impact you and your company is likely to be IR35.
IR35 is the common name for legislation originally enacted in Schedule 12 of the Finance Act 2000. The rules came into force in April 2000. The legislation is intended to prevent employees from setting up limited companies in order to obtain a tax advantage. If you fall foul of IR35 all of the income from your company’s contracts will be taxed as if you were still an employee of the end-user of your services
Although IR35 has been around for over a decade it has not proved popular with contractors (perhaps understandably) but neither has it been successful from the point of view of HM Revenue & Customs. HMRC have put considerable effort into making IR35 work but the bulk of enquiry-status cases taken up by HMRC are won by the taxpayer - in other words IR35 has not achieved what it set out to do. The new coalition government has promised a review of IR35 and most accountants and industry experts hope to see the back of IR35 before too long. There may be some new anti-avoidance legislation in its place or the legislation may be repealed so that we revert to the situation as it was before April 2000. We will keep our clients up to date on the changes planned by government.
Prior to the introduction of IR35, an individual could largely avoid being taxed as an employee by providing those services through a “one man band” limited company. Such companies have come to be known as Personal Service Companies (PSC). The worker could extract funds out of the PSC in the form of dividends instead of salary, resulting in significant tax savings.
IR35 ensures that, if the relationship between the worker and the ultimate client of the PSC would have been one of employment had it not been for the PSC, that the worker pays tax and NIC on a basis broadly equal to that of an employee of the ultimate client. In order to avoid being caught by IR35 you need to ensure not only that your contract is suitably worded but, more than that, you need to ensure that in practice the way in which your company provides services to the end-user is flexible and that without the limited company entity in place that you could still treat yourself as “self employed”.
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