IR35 - What Has It Achieved?

Here is a statement from HMRC, formally the Inland Revenue, as to why IR35 was introduced:

"The purpose of the new rules (IR35) is to remove opportunities for the avoidance of tax and Class 1 National Insurance Contributions by the use of intermediaries, such as service companies or partnerships, in circumstances where an individual worker would otherwise be an employee of the client or the income would be income from an office held by the worker."

In the good old days before IR35 was introduced, contractors (and other self-employed people) were able to work through their own limited companies to provide services to other businesses. The contractor would draw a fairly small salary and take the bulk of their company's revenue in the form of dividends. The benefit of taking a dividend is that it is not subject to employers and employees national insurance contributions. This would enable a contractor to make a substantial tax saving (if you regard national insurance as being a tax, which of course it is).

This arrangement worked very well for contractors, for many years. Unfortunately, Gordon Brown - the then (1999) Chancellor of the Exchequer - had other ideas. He regarded contractors as being 'disguised employees' of their end clients. In other words, the contractors were working for their clients in the same fashion as a real employee of the company did, and as such should be taxed in the same way. This, however, is where the real unfairness began.

Contractors, as emplyees of their own limited companies, have to pay both employers and employees NI contributions on the salary they draw from the company. If the salary is very small, the amount of NI contributions to be paid are also very small. However, if the salary drawn from the company is big, the amount of NI to be paid is also big. It was decided by the Treasury that 95% of the revenue earned by a contractor's company should be paid as salary to the contractor. This meant that both employers and employees had to be paid on this amount, which many would argue is completely unfair as a 'real' employee of a company does not have to pay the 12% employers NI.

In reality, what this meant was that a contractor invoicing £100,000 through his/her limited company would pick up about £63,000, whereas an employee earning £100,000 would pick up about £66,000.

The result of this 'unfairness' was that contractors rebelled against the legislation, and have done ever since. Perhaps if the government had said that 75% of a company's revenue had to be treated as salary, instead of 95%, it would have been a completely different story.

Laws are only effective if people abide by them. Some people might say that the government misjudged how contractors would respond to the IR35 legislation in that the government probably thought that all (or at least the vast majority) of contractors would simply roll over and pay the extra tax. How wrong they were. Contractors, quite rightly, have stood up and fought against IR35 since its inception.

By my own rough and ready research that I have carried out at various sites where there are a large number of contractors, I would say that less than 10% of contractors declare themselves to be inside IR35, meaning that 90% are not paying IR35 taxes. Surely, this is not the outcome the government predicted when it thrust IR35 upon us.

Go back to MyBookkeepingManager User Guides home page