How much more tax do you pay if you are caught by IR35?

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.

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.

Inside IR35

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 2011/12 tax year, if you earn £50 per hour, work 40 hours per week, and 48 weeks per year, and draw down £7,000 as gross salary, your monthly income will be:

£4,678 (inside IR35)

£5,645 (outside IR35)

The difference is almost £1,000 per month due to the increased income tax and NICs payable on income. In this example you’d earn almost 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.

IR35 Calculators

To work out your own personal IR35 calculation, try IR35Calc, Contractor UK, or ask your accountant.