Understanding IR35

If you work on projects for larger businesses through your own Personal Service Company (PSC), both you and that larger business can save tax and National Insurance (NI) costs. Your savings arise if you extract funds from your PSC as dividends rather than as salary, and your customer saves employer’s NI by not paying you as an employee.

The IR35 tax avoidance rules came into effect in April 2000 to prevent individuals from gaming the system and paying less tax by working through their own PSC, when in reality they should be taxed as employees. You, as the director of the PSC, decide whether IR35 applies to your contracts. If it does, you should pay the net proceeds of the contract out of the company as a salary; if you don’t, HMRC will demand the PAYE and NI on an equivalent deemed salary.

To check that IR35 is operated correctly, HMRC has to review the detail of how each contract is performed by a particular PSC, as the law must be applied per contract, not per company. This is very time consuming and expensive, so HMRC want to change the way the IR35 rules are applied.

In the public sector, it is the end customer (the public body) which decides whether IR35 applies to a contract. If it does, the public body instructs the fee-payer in the chain to deduct tax and employee’s Class 1 NI from the amount the PSC invoices. The individual contractor doesn’t get a say in the matter.

HMRC is consulting on extending these public sector rules for IR35 to the private sector. An alternative option is to ask all businesses to record much more information about each contractor they use.

These changes may take effect from 6 April 2019. If you are negotiating contracts which run over that date, include a break clause to allow you to renegotiate your prices.