Not all freelancers may be as lucky as “TV persona” Lorraine Kelly. Check your IR35 status carefully, says David Prosser.
Lorraine Kelly isn’t the most obvious hero for small businesses providing contracting services, but the television presenter’s victory in a landmark tax case is being widely celebrated. Kelly has succeeded in overturning demands for £1.2m of back taxes from HM Revenue & Customs (HMRC) after convincing the courts she isn’t an employee of ITV, but a contractor who is entitled to sell her “TV persona” to the broadcaster through her limited company. For businesses worried about the often tortuous IR35 tax rules introduced almost 20 years ago, that’s a big win.
The ruling underlines how high the stakes can be for freelancers and contractors that set up small businesses in order to offer their services to customers. Since working in this way often has certain tax advantages – a potential income tax and national insurance saving for the company itself and its customers – the Treasury has long suspected some people are playing the system to avoid tax.
There have been several attempts to crack down on such practices in recent years – and more reforms to come – with HMRC’s IR35 regime sitting at the heart of the system. Using IR35, HMRC targets “disguised employees” – people it believes have set up small businesses in order to save tax when working for customers who could just employ them. Not only can HMRC require these people to change their status, but it can also demand payment of back taxes. The problem, however, is that there is no set definition of a disguised employee. HMRC’s inspectors look at each case individually and make an adjudication based on their own judgement.
This can make it difficult for freelancers and contractors to be sure they’re on the right side of the IR35 rules. Plus, the Treasury has upped the ante recently. Any public-sector organisation contracting with a limited company must now assess whether the contractor is actually a disguised employee. If so, they must be taxed as if they were normal employees, with costs for both the employer and the contractor. This requirement, which HMRC hopes will reduce the number of people working “off-payroll”, will be extended to most of the private sector in April 2020.
So it’s essential that anyone running a limited company reviews their IR35 status carefully. While there is no fixed rule on who is and isn’t caught by the regime, asking certain questions will help you plan. For example, do you have control over how, when and where you work? Do you have to do this work yourself, or could you ask someone else to do it in your place? Does your client have to offer you work and do you have to accept? Are you an essential part of your client’s organisation? Does it provide the equipment you need to work? Do you get sick pay, holidays or bonuses? The more of these questions you can say no to, the less chance there is of HMRC ruling you’re actually a disguised employee. In the meantime, the tug-of-war between HMRC and contractors will continue.
Go solo instead?
Freelancers and self-contractors do not have to set themselves up as limited companies. Many choose to operate as sole traders instead. There are pros and cons to both approaches. Limited companies enable you to take money out of the business through a combination of salary and dividend payments. With the latter not subject to national insurance, this can be a more tax-efficient set-up than working as a sole trader, but this isn’t always the case. A limited company also offers you protection from creditors because the debts are in the company’s name, rather than yours.
However, sole trader status is simpler. You’ll manage your tax through the self-assessment system, with no need to file company accounts or complete corporation tax returns. You may be able to do without a professional accountant, saving you money on fees.One potential clincher is that large companies prefer only to deal with other corporate entities, which may make it more difficult to win work from them if you’re a sole trader.