Types of working contracts
Part 2: IR35 doesn't affect every type contract. There are different types to be aware of.
Reading on from the previous section, we have seen how IR35 really only affects the Limited company contractor - so why then are we looking also at the other models? It’s important for us to be aware of the other models as there becomes a point where being caught “inside IR35” might mean that other models are more attractive. Employment status is not a choice a contractor makes - it's defined by law. On top of this, unfortunately a well written contract is not enough by itself. We have to consider practical day to day behaviours too.
1) Limited Companies
Most contractors looking to score the best in tax efficiency are likely to have already got themselves into a limited company setup where they are Director and Shareholder of their own business. They’re likely to be taking a small salary and then the majority of their earnings via dividends. Prior to the tax changes in 2016, this was known to be significantly more tax efficient, but these days it is just marginally so.
Running your own limited company brings certain benefits. You can control your own hours, availability, how you work, choice of your own tools, what work you accept, who you work for and who might do the work (ie, do you subcontract it, employ staff of your own or do it yourself).
Limited Companies often have temporary contracts or set engagements. Their contracts are usually a ‘Contract for Services’ type. This means that they have no employment rights such as sick pay, holiday pay, pension etc.
The taxes a limited company contractor would be subject to are normally corporation tax and self assessment tax. As a result, this is the only type on contract targeted by IR35 and off-payroll regulations.
Limited company contractors have often traded employment rights such as holiday pay, sick pay and a promise of work for the flexibility of being under their own rules and control and the benefit of marginally preferential taxation rates.
Most readers here will be familiar with the employment type of working contract. These contracts offer the most in security and consistency, but the least in potential tax efficiency. Known as ‘staff’, these employees will be paid on fixed dates each month and will be subject to normal PAYE and national insurance. The employer will also be paying employers national insurance as an additional cost to the company. This is the first difference to the company engaging the person. Employers national insurance is an additional cost that they will bear.
Employment also brings hidden additional costs such as sick pay and holiday pay. These add protections on the staff member as a part of the rights as employees.
The name given to contracts of this type is usually a ‘contract of service’ (rather than a 'contact for services'). This is where Mutuality of Obligation (MOO) comes in - employers are required to provide work to the employee and the employee is required to complete the works requested. There is usually no opportunity to delegate the work required to a subcontractor and there is often a large degree of control on the employee dictating things like hours, tools used, methods and ownership of the product of the work done.
Employment therefore offers the security of work, pay and rights. This could be a good trade-off to consider should you find yourself ‘inside IR35’. But for the ‘employer’ it costs more in associated taxes.
When it comes to tax law, you may have heard of zero-hours contracts. These are usually a type of ‘employment’ but there are some differences that define these as ‘workers' in their own category. Firstly, MOO doesn't exist. Employers do not have the need to provide work and workers have no obligation to accept the work offered. There is a limited possibility of substitution - ie another ‘worker’.
Just like employees, workers are controlled by the employer and they are subject to the same taxes and national insurance factors. It’s for this reason that they are not affected by IR35.
This type of contract is listed here as an alternative as it retains an element of control by the contractor without the commitment of the employer to provide work.
Contractors caught ‘inside IR35'
Considering the above working models and now knowing that being caught inside IR35 means you pay more taxes, it’s important to now work out which method of contracting would be best positioned for your scenario. Being a Limited company retains all the control you enjoyed before, but you have all of the financial burden of IR35 to bear yourself.
You can share this burden by switching to employment on worker status, but in doing so you sacrifice something of the freedoms you previously created. In some cases, the rights that you gain are worthwhile the sacrifice.
Meanwhile for the employer, contractors being caught inside IR35 will be looking to mitigate the impact. By closing the doors to employment or worker statuses (which come with the additional rights and national instances to consider) you may be closing the door to a certain pool of talent. It is therefore important to consider the employment or worker statuses to ensure you have the right people performing the work for the business.
Regardless of the type of intended employment status, it’s important to be aware of our day to day practises. Employers exerting too much control on a limited company could flip the balance between being inside or outside IR35. Also, Limited companies looking for employments rights or working outside the scope of the engagement could do the same. This therefore reinforces the need to constantly review the relationship to ensure that the intended status is maintained.