The various tax benefits that can be enjoyed as a limited company contractor are one of many reasons why skilled individuals decide to go down this route and become the director and shareholder of their own limited company.
At the same time, setting up your own limited company involves a lot of paperwork which can be both confusing and time-consuming. On top of this, there is the very important issue of IR35 compliance.
What is IR35?
IR35 is a piece of legislation that allows HM Revenue and Customs (HMRC) to determine whether contractors are in business in their own right or in fact 'disguised employees'.
Prior to the introduction of the legislation, taxes could be avoided if contractors provided services to clients via a limited company and took money out of the intermediary in the form of dividends as opposed to a salary.
Can IR35 be avoided?
Tax avoidance is a serious issue and can have severe legal consequences.
There are companies that claim to be able to help you avoid the tax even if you fall within it. While this may appeal to you in terms of greater take-home pay, the H M Revenue & Customs (HMRC) can investigate cases where they feel a contractor is in fact a 'disguised employee'.
What are the consequences of IR35 avoidance?
One of the most famous cases of IR35 avoidance came in 2008 when HMRC successfully argued in the High Court that Dragonfly Consultancy Limited director John Bessell 's limited right of substitution and the fact he paid for his own training did not satisfy the criteria of self-employment.
In addition, his client – the AA – exerted a high level of control over Mr Bessell, which was interpreted as a strong indicator of employment.
One of the key elements of this case was the fact that there were a number of contracts with the same client which began before the legislation was introduced. After it became law, clauses which were deemed 'IR35 friendly' were inserted.
This was interpreted by many commentators as being a move designed to get around the legislation, thus their credibility was undermined from the start and the Special Commissioner and the High Court were not convinced.
The result was that Dragonfly had to pay more than £99,000 in taxes.
How can you ensure compliance with IR35?
The consequences of breaching IR35 legislation can be significant not just in terms of your finances but also your reputation.
If you use a limited company service to establish your business, they should explain to you the importance of IR35 compliance.
As well as being able to claim the unpaid taxes, HMRC can apply penalties which can be as much as 100 per cent of the tax you have avoided.
If tax legislation and finances are not your strong point, you can employ an accountancy service provider to ensure that you pay the right amount of tax to the relevant bodies.
When choosing such a service provider, it is essential you select one with a strong emphasis on compliance. Some organisations will look for various loopholes that can be exploited to help reduce your tax liability.
However, the Dragonfly case is something you should keep in mind, as it demonstrates that the authorities are prepared to investigate contractors they feel are abusing the law, which could see you incur a huge tax bill in addition to fines and other penalties.
A reputable accountancy service provider will ensure you comply with IR35 legislation. It may cost you more, but the chances of you becoming the next Dragonfly are low.
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