Does inside IR35 offer any tax breaks if I’m a limited company contractor?

An article on ContractorUK extolling the benefits of effective tax planning as a contractor was responded to by one contractor who observed “Inside IR35 work does not allow for deductible expense claims,” writes Matt Fryer, managing director of Brookson Group, a People 2.0 Company.

IR35 timeline

What’s beyond doubt is that since April 6th 2017 in the public sector, the responsibility to determine whether or not a limited company contractor engagement fell inside or outside of IR35 shifted to, and was placed upon, clients.

Likewise since April 6th 2021, this responsibility on end-users has been rolled out to medium and large companies in the private sector, too, forcing them to decide whether or not the contractor engagement fell within or outside of IR35.

The above potted history will be stating the obvious to some contractors, but this shift is part of understanding the tax efficiency -- or not -- of being a limited company with an inside IR35 assignment.

Being outside IR35 and what it means for expenses and pay

If the contract does not fall within IR35, the contractor is generally going to continue to operate via their limited company, as usual. In reality, this would mean collecting gross income from the end-client and/or agency, and offsetting deductible expenses, to arrive at the company’s taxable profit. 

And as per HMRC guidelines, tax deductible expenses must be “wholly, exclusively and necessary” for your business.

Essentially, this means that the expense must directly relate to your company’s business activities.

There also should not be any personal element to the payment. The company will then pay corporation tax on the residual profit. Most directors of limited companies (also known as Personal Service Companies- PSCs) will also adopt the policy of paying themselves in a tax-efficient manner through a combination of low salary and high dividends.

So in this instance (i.e. outside IR35), there’s quite a significant range of tax-efficiencies to explore.

Being inside IR35 and what it means for your income

As mentioned at the top, on April 6th 2021, it became the responsibility of the end-client (the party engaging the worker) to determine whether or not the engagement fell within or outside of IR35. To do that in accordance with the off-payroll working legislation, the client as the deciding party must issue a Status Determination Statement which states the worker’s employment status – either as an employee (inside IR35) or self-employed (outside IR35).

If the contract is inside IR35, the end client, or fee-payer (in the case of recruitment agencies) is responsible for calculating, deducting, and paying income tax and national insurance liabilities.

The PSC then receives the net amount of their sales invoice raised (less income tax and Employee’s National Insurance), plus any VAT charged on their sales invoice (if they are VAT registered).

Tax disadvantages and inefficiencies when inside IR35

In a nutshell, when your IR35 status is changed to inside IR35, you will lose the ability to pay yourself tax-efficiently through a combination of low salary and high dividends.  

However, IR35 income is deemed a legitimate business expense, so it will reduce your corporation tax bill significantly. In company terms, there is very little profit left to offset any expenses. This is to ensure there is no double bite to tax, as your fee-payer will provide you with form P60 at the end of the tax year to disclose on your self-assessment return.

Contractor expenses you can and can’t claim if inside IR35

Travel and subsistence expenses, such as mileage, accommodation, meals and other ad-hoc costs are not deductible expenses on inside IR35 contracts.

This is because the worker is deemed an employee, and as such, travel costs which an employee incurs for regular attendance in the performance of the duties of employment is to a “permanent workplace”, in accordance with s339 ITEPA 2003.

In effect, regular commute costs to your place of work as an employee does not benefit from tax relief.

For out-of-pocket expenses, where a contractor could have claimed a deduction against their earnings under normal employment income rules, those expenses are allowed in the case where the contractor was employed by the client at some point -- and met those expenses with those earnings.

Having said that, expenses incurred as result of employment are generally difficult to claim, as they must satisfy the ‘wholly, exclusively, and necessarily’ test -- under s336 ITEPA 2003. In other words, they must be absolutely necessarily incurred in the performance of employment duties. This is an exceptionally difficult hoop for an employee to jump through and is an area that HMRC stringently reviews.

Where inside IR35 contractors can still claim tax relief...

Importantly, inside IR35 contractors can still claim tax relief on pension contributions made via their personal service company.

In addition, professional subscriptions and business insurance might still be deductible -- with the proviso that these expenses meet the “wholly, exclusively and necessary test” outlined above. Be aware, though, there does need to be sufficient profits left in the company to absorb these expenses to make these company deductions worthwhile.

Either way, as you can see, the tap of tax efficiency isn’t totally turned off just because an inside IR35 contract is in place.

Are there any tax perks of being insider IR35?

There are no real HMRC-related benefits of being inside IR35 -- essentially you will pay more tax and lose the opportunity to claim travel and subsistence allowances.

However, ‘inside IR35’ does imply that the contractor will avoid significant HMRC bills for unpaid taxes, interest, and penalties if they are caught outside IR35 (when they should be inside IR35) as taxed on an employment basis.

Also, and potentially overlooked, the VAT legislation continues to apply -- therefore, if you meet the criteria for the flat rate scheme, you could be eligible for the flat-rate benefit. As a limited cost VAT trader, a PSC would pay over 16.5% VAT on their gross VAT receipts to HMRC VAT, rather than the full 20% VAT collected on sales, leaving a very modest amount retained by the company as flat rate vat income.

Contractors, don't forget the non-IR35 captured portion of income

The IR35 legislation is controversial in that contractors must pay the same taxes as workers, but without the safety, security, or statutory benefits associated with the employment. Most contractors would prefer to work outside IR35 since they earn more money and as such, working through their PSC while wholly inside IR35 is unattractive and many will opt to work via an umbrella company in these circumstances.

However, if you’re working on a combination of inside/outside IR35 assignments via your PSC, this does allow you to benefit from the usual tax efficiencies and expenses claims relevant to the non-IR35 captured portion of your income. Perhaps that’s a good reason to double-down on tax efficiencies as a limited company, with the help of your accounting adviser, albeit on the company’s income not caught by IR35 -- which may relate to only a three-month contract.

Tax efficiency isn't the only the IR35 / OPW question to ask...

On a separate note, is the assignment correctly assessed as caught by the off-payroll working rules, and was "reasonable care" taken in coming to that conclusion?

We believe it is imperative that your contractor limited company receives a fair and proper IR35 evaluation that appropriately assesses your employment status. Remember, there is legislation in place permitting you to challenge the outcome of your status determination statement if you -- and your bonafide contracting business -- don’t agree with the outcome. So having a contract review that demonstrates that you used due diligence in deciding whether you fall within or outside of IR35 can especially help if you are looking to challenge your IR35 status.

We would always advocate taking specialised advice from a reputable, experienced and qualified contractor accountant to assist in adapting your business status as appropriate whether you are inside IR35 or outside IR35 -- and to consider all the options available to you as a professional contractor.

Wednesday 29th May 2024
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Written by Matt Fryer

Matt is a Chartered Tax Advisor with 18 years' experience of advising on tax planning and compliance. Matt has been with Brookson since 2009, having previously worked for Big 4 accountants, KPMG and PwC. Matt’s primary role is to ensure that the services provided by the Brookson Group comply with relevant legislation and regulatory requirements. Matt is also a Board member of the FCSA, the UK's leading membership body dedicated to promoting supply chain compliance for the temporary labour market.

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