Navigating the complexities of tax laws and employment status can be challenging, especially if you are self-employed. In the United Kingdom, a regulation that holds significant importance for sole traders is the IR35.
In this blog, we have already covered what IR35 is and what it means to be “inside IR35”. In this article, we will focus on what “outside IR35” means and what individuals should have in mind when it comes to tax contributions. Understanding the implications of these rules is crucial for those who wish to maintain their status as self-employed workers.
Being classified as “outside IR35” offers numerous benefits, including greater flexibility, increased control over working arrangements, and potential tax advantages.
What does it mean to be “outside IR35”?
IR35 refers to the legislation that determines the tax status of individuals who provide services through an intermediary, such as a limited company or a partnership. In this context, being “outside IR35” means that, for tax purposes, an individual is regarded as self-employed.
To determine whether an individual falls inside or outside IR35, the HM Revenue and Customs (HMRC) looks at the nature of the working relationship between the individual and the client they are providing services.
Once a worker is considered to be outside IR35, they are responsible for managing their own tax and National Insurance contributions. They may also be eligible for certain tax advantages, such as claiming business expenses and potentially paying less tax than an employee.
Determining IR35 status can be complex. Many factors can influence the decision. Therefore, it is advisable to always seek professional advice to ensure compliance with the relevant tax laws.
What constitutes self-employment?
As discussed, when workers are considered “outside IR35”, they are self-employed. In the context of UK tax laws, several factors are taken into consideration to determine a person’s employment situation.
Here are some characteristics that the HMRC might consider to determine if an individual falls inside or outside IR35:
Self-employed individuals have a significant level of control over their work. They determine how, when, and where they carry out their activities. They also have the freedom to decide on the methods, processes, and tools used to complete their tasks.
A self-employed worker has the right to provide a substitute or delegate the work to someone else, if necessary, without the need to ask permission from a client.
Workers who are self-employed bear all of the financial risk associated with their work. They need to cover their own business expenses and may be liable for any mistakes or errors made.
Mutuality of obligation
In self-employment, there should be no ongoing obligation for the client to provide work, and the individual is not obliged to accept any work offered. The relationship is project-based.
Self-employed individuals are typically not integrated into the client’s workforce, maintaining an independent business identity from the organisation for which they provide services.
The way in which an individual is paid is also an indication of their employment status. Self-employed individuals are often paid a fixed fee for a specific project or task rather than receiving a regular salary or hourly wage. They may also have multiple clients.
The benefits of self-employment
Being self-employed offers numerous benefits. Here are some of the advantages of being outside IR35:
As a self-employed individual, you have the freedom to make your own decisions regarding your work. You have control over the projects you take on, the clients you work with, and the direction of your business. This level of autonomy allows you to align your work with your personal goals and values.
Self-employment provides flexibility in terms of setting your own schedule and determining your working hours. You have the ability to choose when and where you work, allowing for a better work-life balance. This flexibility is especially beneficial for those with personal commitments or diverse interests outside of work.
Unlike traditional employment, where your income is often fixed, self-employment allows for unlimited earning potential. As a self-employed individual, you have the opportunity to directly benefit from your hard work and the success of your business. You can set your own rates and negotiate contracts based on the value you provide.
Variety of work
Self-employment often brings a variety of work experiences. You can choose to work on different projects with diverse clients, which keeps your work engaging and exciting. This variety can help you develop a broad range of skills and expertise in different areas, enhancing your professional growth.
Self-employed individuals may have access to certain tax advantages. You can deduct legitimate business expenses, such as office supplies, equipment, travel costs, and even a portion of your home office expenses. These deductions can help reduce your taxable income and potentially lower your tax liability.
Personal and professional development
Being self-employed requires wearing multiple hats and taking on various responsibilities, which fosters personal and professional growth. It offers opportunities to learn new skills, improve your business acumen, and develop a strong entrepreneurial mindset.
Self-employment encourages self-motivation, problem-solving, and continuous learning.
While self-employment comes with risks, it can provide a sense of job security. As a self-employed individual, you are not reliant on a single employer or client. Having a diverse client base can help mitigate the impact of losing one client or project, providing a level of stability and resilience.
Self-employment often allows for creative freedom and the ability to pursue your passion. You have the opportunity to shape your business in a way that reflects your unique skills, interests, and values. This creative control can lead to increased job satisfaction and fulfilment.
The costs of being outside IR35
If an individual is treated as self-employed for tax purposes, they have a few obligations that they need to pay attention to.
Here are some of the taxes people outside IR35 may be required to pay:
Self-employed individuals are responsible for paying income tax on their profits.
The tax is calculated based on the individual’s annual taxable income, which is the total income earned from self-employment minus allowable business expenses and deductions. Income tax rates and thresholds can vary from year to year, so it’s important to stay updated with the latest rates.
National Insurance Contributions (NICs)
Self-employed individuals are also liable for paying National Insurance contributions. There are two types of NICs relevant to self-employment:
Class 2 NICs
These are flat-rate contributions payable by self-employed individuals if their annual profits exceed a certain threshold (set by the government). The amount is typically paid on a weekly or monthly basis.
Class 4 NICs
These contributions are based on the individual’s annual taxable profits. Class 4 NICs are calculated as a percentage of profits above a certain threshold and are paid alongside Income Tax through the annual self-assessment tax return.
You can learn more about NICs rates here.
Value Added Tax (VAT)
If the individual’s self-employed business turnover exceeds the VAT registration threshold (currently £85,000 in the UK), they may need to register for VAT and charge the tax on their goods or services.
VAT is a consumption tax paid by the end consumer, but businesses act as intermediaries in collecting and remitting the tax to HMRC.
Depending on the nature of the self-employed business, there may be other taxes to consider, such as Corporation Tax (for limited companies), Capital Gains Tax (on the sale of certain assets), or Stamp Duty (on property transactions). These taxes may not be applicable to all self-employed individuals and depend on the specific circumstances of their business activities.
It’s important for self-employed individuals to keep accurate records of their income, expenses, and other relevant financial information to ensure accurate reporting and payment of taxes. Seeking professional advice from an accountant or tax advisor is recommended to navigate the complexities of tax obligations and ensure compliance with UK tax laws.
How to continue being self-employed
To continue being outside IR35, it’s important to ensure that your working arrangements and the nature of your self-employed business reflect genuine flexibility rather than an employee-employer relationship.
Remember, IR35 determinations are based on the specific facts and circumstances of each case. By maintaining a genuine self-employed status and aligning your working arrangements with the characteristics of self-employment, you can increase the likelihood of being considered outside IR35.
Here are some tips you can follow to continue to work as a self-employed individual, falling outside IR35:
Review your contracts
Ensure that your contracts clearly reflect the nature of the working relationship as self-employment. Contracts should emphasise factors such as control, substitution, and lack of mutuality of obligation. Seek legal advice to ensure your contracts are appropriately drafted to support your self-employed status.
Maintain control and autonomy
Retain control over how, when, and where you carry out your work. Avoid being subject to significant control and supervision by the client. Maintain the ability to decide on methods, processes, and tools used in your work.
Demonstrate financial risk
Assume and demonstrate the financial risk associated with your business. This includes having responsibility for business expenses, providing your own equipment, and potentially having liability for mistakes or errors in your work.
Show client diversity
Work for multiple clients or have a clear plan and evidence of actively seeking new clients. Avoid long-term exclusive contracts that may resemble an employer-employee relationship.
Avoid employee-like benefits
Refrain from receiving benefits commonly associated with employment, such as paid holidays, sick pay, or employee benefits packages. Self-employed individuals typically do not receive these benefits.
Maintain an independent business
Present yourself as a separate business entity, distinct from the client’s organisation. Avoid being integrated into the client’s workforce, such as using their email address, participating in employee training programs, or attending staff meetings.
Seek professional advice
Consider consulting with a tax advisor, accountant, or legal expert who specialises in IR35 and self-employment matters. They can provide personalised guidance based on your specific circumstances and help ensure compliance with tax laws.
Maintaining self-employment status outside the realm of IR35 is crucial for individuals who value autonomy, flexibility, and the benefits that come with being in control of their own business. By understanding the factors that determine self-employment, the associated tax obligations and implementing effective strategies, professionals can confidently operate as genuine independent contractors.
Remaining outside IR35 opens up a world of possibilities for self-employed professionals. It allows them to choose their clients, negotiate contracts, and determine the terms and conditions of their work. It also offers the potential for tax advantages, such as deducting legitimate business expenses, thereby optimising financial outcomes.
As the landscape of self-employment continues to evolve, staying informed and proactive is paramount. Regularly reviewing working arrangements, contracts, and practices ensures that self-employed individuals maintain their independent status and mitigate any risks associated with being incorrectly classified as employees.
By embracing the knowledge, tools, and strategies outlined in this article, individuals can confidently navigate the complex terrain of IR35. Upholding genuine self-employment not only safeguards their autonomy but also enables them to thrive in a dynamic and competitive market.