Financial Impact of IR35 on Contractors

Introduction

The financial impact on Contractors caught by IR35 is significant, resulting in the payment of much more tax. This article explains what the extra taxes are, and how much they are likely to be.

To start with let’s look at both scenarios and then compare some actual figures.

You can compare figures for your own personal scenario using the IR35 Taxes Calculator.

Outside IR35 – Taxes avoided and paid

Contractors outside IR35 typically use a limited company structure for their payments. They pay themselves a low salary with the rest paid in dividends.

This structure results in the following:

• Employers N.I. of 12.8% avoided on all revenue.
• Employees N.I. of 11% partially avoided, since upper bracket not reached.
• Employees N.I. of 1% completely avoided on all revenue, since upper bracket not reached.
• PAYE of 40% completely avoided, since higher rate tax bracket not reached.

The contractor does however pay corporation tax of 19% on all profits, after expenditure.

Finally, the contractor pays further taxation on their dividends if their total personal income (salary + dividends) falls within the higher rate bracket. In this case the contractor pays an extra 25% on the amount falling within the higher rate bracket, due to tax credits on dividends.

Inside IR35 – Taxes paid

Contractors inside IR35 typically use an umbrella company, since it is cheaper than the limited company structure which provides no real benefits when caught by IR35. If the contractor still uses a limited company the tax calculations are the same.

The ‘inside IR35’ structure results in the following:

• Employers N.I. of 12.% applied to all gross earnings*.
• Employees N.I. of 11% paid on all earnings within lower bracket.
• Employees N.I. of 1% paid on all earnings within upper bracket.
• PAYE of 40% paid on all earnings within higher rate tax bracket.

* Gross Earnings = (Revenue – Expenses) * (1/(1+employers NI rate))

In this scenario all taxes are fully paid. The only way to minimise tax is to take full advantage of any available expenses benefits.

Comparing actual figures for inside and outside IR35

As you can see from the figures, the financial impact of IR35 on contractors is significant. Not all is lost, and avoiding IR35 is certainly possible...

Take action – What you can do

Contract Review: It is important to take IR35 legal advice to get your contract reviewed. Engage an IR35 expert before signing any new contract to ensure you have the maximum chance of passing IR35.

Pensions: You can reduce the pain of IR35 with a contractor pension by channelling pre taxed income straight into a pension, obtaining up to 48% tax relief. For each £100 invested your net pay reduces by only £48.

Published: Wednesday, May 31, 2006