IR35 came into effect 6th April 2000. Its aim is to tax contract workers who the government felt were avoiding paying sufficient tax, ie. contractors who declared themselves self-employed while working for just one organisation. Those who fall under IR35 are liable to pay Schedule E and National Insurance after the deduction of expenses.
Many contract companies generally have a mixture of IR35 and non-IR35 taxable income. Income that does not fall under normal contracts is not IR35 taxable.

Employed or self employed?

IR35 will only come into force in cases where the contractor is deemed 'employed'. It affects people who would have been given contracts of employment if they had worked directly for a company, rather than having gone through an intermediary such as a service company or a partnership.

If you think that you are 'self-employed' and feel that you do not fall under the new regulations it is a good idea to diversify your work. However it may be safer to assume that you are affected and to seek advice either from an accountant or HMRC, which has a service where you can send them your contract and they will tell you whether you fall into the IR35 net or not.

Dealing with IR35

Most contractors are worried about being taxed as an employee but missing out on all the normal perks such as paid holiday and sickness benefits. Normally their income would have been sufficient to compensate for this lack of benefit but now there will be a noticeable difference in their end of year income.

One way to get over this is to increase rates. Financial advisers recommend that contracts should charge some 15%-25% extra to cover the short fall in income. This is going to become common, so if your contract is up for renewal you could ask for an increase in payment.

Another way to save money is to organise your expenses, so that you are claiming back as much as possible. The government conceded to give contractors a 5% expenses provision, so make sure you use it. Eligible claims are:

Accounting fees

Computer equipment

Company secretary salary

Postage & stationery

Training costs

Computer equipment depreciation

Employer and public liability insurance

Contractors are still liable to pay Schedule E income tax, and therefore retain all the normal tax relief including:

Pension payments

Business travel


Professional indemnity cover

Benefits in kind

It is important to plan any expenses in advance taking all these things into consideration, such as buying software to avoid paying the 40% tax on the rest of expenses that exceed the stated 5%.