The Financial Impact of IR35: A Case Study

IR35 is a significant problem for thousands of contractors and freelancers around the country. Many of these individuals have one major client on which they rely for the bulk of their income. There is nothing inherently wrong with this arrangement, but clumsily drafted legislation has meant that many self-employed people are treated as ‘disguised employees’ for tax purposes.

This can result in a significant increase in these individuals’ tax burden. Often, contractors and freelancers caught inside IR35 can see their take-home pay reduced by as much as 25%.

This case study concerns a copywriter, Michael, who works for a number of clients on an ongoing basis. Based in London, he provides content for various businesses in the UK and USA. For the first three years of his self-employed career, he had a large number of clients for which he produced occasional but repeat work. “Most of my work was small projects, but I would do a number of projects for each client over the course of each year,” he said.

Long-term Contracts

However, around a year ago Michael negotiated a long-term contract with a firm in London. “The deal was that I would provide a set amount of content for them each month. It was a set-length contract, but the understanding was that it would be renewed at the year end.”

In theory, the terms of the contract left Michael outside the remit of IR35. He set his own hours, and had a clearly defined schedule of work. “As far as I was concerned,” he said, “this was to be treated in the same way as the work I do for any other client.

“But I made one major mistake – I was named personally in the contract. So everything I was paid was just being treated as regular income as far as the taxman was concerned. Basically this meant that any tax advantages I would have had from being a contractor were counteracted by IR35.”

Company Formation

When it came to renewing his contract at the end of the year, Michael set up a Limited Company. Instead of having his own name appear on the contract, he wrote in that of his limited company. “The company was really easy to set up. I used a company formation agent, and it cost about £60.”

The client now pays the company, rather than Michael personally. He then pays himself from the company, by way of a Dividend. “I am the sole shareholder, so I just take the income by making dividend payments to myself. It is a bit of a hassle because of the paperwork involved, but I save about £7,000 a year in tax so it is definitely worth it.”

In order to ensure that the dividend payments are accepted by HM Revenue & Customs, Michael has to draw up dividend receipts, and minutes of board meetings. He chooses to keep an accountant on retainer to help him do this.

If you are considering using a limited company to help avoid IR35, you should always consider Taking Professional Advice from the outset. While company formation is a simple process, arranging dividend payments and other tax affairs can be difficult. IR35 liabilities can be applied retrospectively, so it is imperative that you have the proper arrangements in place from the very beginning.