Contractors' Questions: Does IR35 apply to all limited company contractors?

Contractor’s Question: All limited company contractors I speak to seem to talk very seriously about IR35 but surely the legislation does not apply to all of them, or does it?

Expert’s Answer: In simple terms, all contractors who supply their services through a limited company need to consider IR35.

IR35: a potted history

The ‘IR35 rules’ collectively refer to the intermediaries legislation first introduced in 2000, which have since evolved to include the off-payroll working rules – specifically in the public sector since April 2017, with broadly the same framework due to apply in the private sector from April 6th 2021 (bar an exception where the end-user is a small company, in which case the 2000 legislation is potentially in play).

These rules have been designed to make sure that all limited company contractors (also known as ‘PSC’ or Personal Service Company contractors) pay the correct amount of tax based on their employment status. Broadly-speaking, if such a contractor behaves more like an employee than an independent contractor, their contracting income should be treated as employment income and taxed as if they were employee.

Who’s responsible for working out if IR35 applies

Until April 6th 2017 in the public sector, it was the responsibility and liability of the contractor to determine their IR35 status. If they were inside IR35, it meant that IR35 rules applied and they would end up paying more tax, whereas if they were outside IR35, the rules did not apply, and they would pay less tax.

Historically, contractors struggled with interpreting the IR35 rules, with HMRC claiming that many contractors had incorrectly determined their employment status to be outside IR35.

With so many limited company contractors operating in the UK, HMRC struggled to enforce compliance, so the off-payroll working rules were introduced on April 6th 2017 for all limited company contractors providing services to the public sector to abide to. Crucially, these new rules and their variant from April 6th this year in the private sector (other than where the end-user qualifies as a small company) require the end-hiring organisation to assess each contractor’s IR35 status. This shift in the decision-making power has led to many more engagements being determined as inside IR35.

As mentioned, these rules from 2017 have recently been amended and will soon be extended to include the private sector, meaning all but the smallest of UK-based organisations who hire limited company contractors from April 6th 2021 must now assume the responsibility, and ultimate liability for their contractors’ IR35 status.

The Small Company Exemption

The rules around what define a ‘small company’ are themselves fairly complex, but in broad terms small comes from the small companies regime as defined by Chapter 382 of Companies Act 2006.

The end-hiring organisation qualifies as ‘small’ if after its first completed financial year at least two of the following conditions apply:

• Annual turnover – not more than £10.2 million
• Balance sheet total – not more than £5.1 million
• Number of employees – not more than 50 employees

When the small company exemption applies, the IR35 rules – those originally set out in Chapter 8 of Income Tax (Earnings and Pensions) Act 2003, apply, meaning that the contractor remains responsible and liable for determining their own IR35 status. Best of luck navigating this evolving legislation!

The expert was Chris Mattingly, chief executive of IR35 Navigator.