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The effects of IR35

14th February 2013 Print

In the United Kingdom, IR35 is a form of tax legislation that was created to tax workers who try to disguise their employment. The IR35 legislation is taxed at a similar rate to typical employment, and it means that disguised workers, who receive client payments via intermediaries, are taxed as if they are actually employees of that client.

Before such legislation was introduced, people who ran their own business were able to receive direct payment from clients direct to their company. They could then use this company revenue just like any small company. Profits would be distributed as dividends to shareholders, meaning they would not be subjected to National Insurance Payments.

Furthermore, owners of the company could reduce their tax bill by dividing ownership between family members, subsequently placing the company in a lower tax bracket. After the introduction of the IR35 legislation in 2000 however, freelance workers were subjected to serious implications if they tried to avoid national insurance contributions by distributing share dividends instead of paying themselves a salary. Let’s take a look at some of the effects of IR35.

Criticism Of IR35

The IR35 legislation has been criticised on a variety of levels by several public bodies, including a number of professional freelancers, contractors and sole trader associations. Tax experts believe that the IR35 legislation does not achieve its aim of taxing sole traders of freelancers at the same level of employees, as those who abide by IR35 actually pay much higher levels of tax. Furthermore, the level of complexity IR35 exhibits is harmful to smaller companies that exist for reasons other than tax evasion.

Additionally, confusion continues to surround whether the IR35 legislation applies to individual contracts, with the Inland Revenue only providing their stance on the contract once it has been signed. Therefore, negotiations regarding payment must be made in ignorance of taxation costs. Finally, many feel that IR35 is unfair towards workers in small family businesses, as they do not receive any legal state benefits like normal employees, even though they are taxed as such.

Effectiveness Of IR35

Since 2010, the Inland Revenue has refused to publish any figures regarding IR35, meaning it is very hard to judge the effectiveness of the legislation. However the initial impact assessment for IR35 taxation stated that the government expected to make around £220m every year in NI contributions, as well as around £80m in Income Tax.

The effectiveness of IR35 legislation depends very much on the HMRC’s motivation to target the self-employed and contractors. Tax experts have suggested that due to the lack of evidence on the effectiveness of IR35 legislation, it is obvious that targeting contractors offers poor return on investment. Furthermore, the continued implementation of barriers for contractors in the form of costly legislation has the potential to damage the UK’s competitiveness.

Faced with such obstacles, the UK may still face a vast reduction of contractors operating altogether. Having to pay the same amount of tax as permanent employees but sharing none of the perks, such as holidays or sick pay, just doesn’t seem fair.