If your contracts are caught by the IR35 rules, the financial impact will be considerable. Here, we look at the tax difference you will incur if you are inside or outside IR35.
As a limited company contractor, you will typically draw a modest salary from the company, which minimises your exposure to employers’ and employees’ National Insurance Contributions (NICs), and income tax.
The bulk of your income will be in the form of dividends, which can be paid from the company’s post-tax profits. No NICs are payable on dividends.
For any relevant engagements which are caught by IR35, following deductions for a flat 5% allowance for administration expenses, plus some other allowable ‘Section 336’ expenses and possible capital allowances, the bulk of your income will be in the form of a ‘deemed salary’.
Your income will be subject to the same levels of taxation as a normal employee, although you may still benefit from some aspects of working via a limited company still, such as joining the Flat Rate VAT Scheme.
An in-depth guide to calculating the deemed salary can be found on the HMRC site.
The cost of IR35
The difference between the take-home pay of a contractor inside and one outside IR35 is significant.
For example, in the 2019/20 tax year, if you draw down £12,500 as gross salary, your annual income after tax will be:
£32,492 (inside IR35)
£40,937 (outside IR35)
The difference is over £8,445 per year due to the increased income tax and NICs payable on income. In this example, you’d earn around 20% less if you are caught by IR35.
This calculation is provided purely to illustrate the financial cost of IR35 and takes into account certain assumptions.
To work out your own personal IR35 calculation, try this handy IR35 Tax Calculator at ContractorUK.com, or ask your accountant.