Many of those who are new to IT contracting may wonder what IR35 is and how it will affect them. We explain here.

Previously, most contractors, especially IT contractors, generally used limited companies. Their income is paid into there and they extract expenses and salary from it before paying both Corporation Tax and personal tax.

Several years ago, the Government decided that some classes of contractor were really not contractors at all.

What they were really looking at were those people who were permanent on the Friday at a company and the next Monday they had become contract staff.

They felt, probably correctly, that these were disguised employees and that this was just a ruse on the part of the company and the new ‘contractor’ to avoid taxation.

New Law

Therefore they brought in IR35 to put this right.

What would happen in the future, said the Government, is that all those companies who were really small businesses, including IT contractors, would continue to be looked at as small businesses and treated accordingly for taxation purposes.

However, those who were really ‘disguised employees’ according to Government thinking, would be taxed as if they were employees.

They would not be allowed to claim any more than 5% of their income as expenses. Then they would pay tax at the full rate.

Caught in the Net

However, the new rules caught out more than it was thought that they were intended to catch.

In fact formal Paymaster General, Dawn Primarolo, said as much at a working breakfast with the Professional Contractor Group (PCG).

She said that the law was catching out more than it should have done.

It meant that many contractors were potentially inside IR35.

The Professional Contractors Group, indeed, was set up to fight IR35 and to lobby for its abolition.

Three Routes

Nowadays it looks like contractors have gone down one of three routes:-

1) They have simply paid up their full whack of tax
2) They have joined an Umbrella Company which allows them to deduct expenses
3) They have continued to trade as limited companies without paying IR35

The Professional Contractors Group fought a High Court case, funded by contractors, which they lost.

They then lost an appeal, again funded by contractors, at the High Court.

They also lost an appeal against the General Commissioners verdict on an IR35 case at the High Court.

Learning Process

However, along the way they learned a lot about how the Government and the Inland Revenue thought about IR35 and who it would include.

They also learned a lot about how the judiciary and the Special Commissioners and General Commissioners would view who was caught by IR35 and the correct route to take when fighting an IR35 case.

It is this information, gleamed from what might be classed as failures, that has allowed more and more contractors, giving them the information that will help take them outside IR35.

Contractors are far more flexible than the Inland Revenue and can change their contractors with agencies and clients to help get their contracts as being classified as being outside IR35.

Important Point

In fact that is a very important point to make. Contractors are not inside or outside IR35. It is contracts that are in or out.

It could be that a contractor has three contracts in a row, where the first is outside, the second is inside, and the third is outside again.

The Professional Contractors Group continues to lobby for the abolition of IR35 or at least for more classifications of contractors to be outside of IR35.

They are having more and more success as fewer and fewer contractors are now paying the tax, either by putting themselves inside Umbrella companies, or by staying as limited companies and changing both their contracts and working conditions so that they are outside of IR35 and don’t have to pay tax as ‘disguised employees’.

It is important to note that these so-called ‘disguised employees’ get none of the benefits of being an employee but are only considered as employees for taxation purposes.

Tories not Clear

The Conservatives have not clarified yet what they would do about IR35. They said that they would abolish it but replace it by something else which they have not clarified yet.

However, the ex-Shadow Chancellor, Oliver Letwin, told PCG members at a meeting that he had a certain sympathy with the Chancellor Gordon Brown over IR35, so it, or something similar, may be around for some time to come yet – regardless of the hue of the Government.