How the IR35 off-payroll rules will change from April 6th 2024

Whichever way you look at it, the introduction of the off-payroll working rules – introduced in the public sector on April 6th 2017 and the private sector on April 6th 2021 – made engaging contractors more burdensome for businesses.

One of the biggest perceived challenges is the liability, which was transferred from contractors to fee-paying parties -- typically the end-client or recruitment agency.

But this financial risk was made greater by what has been coined the ‘double taxation’ of IR35 under the off-payroll working rules, writes IR35 contract review expert Seb Maley, CEO of Qdos.

Disincentive, risk-averseness, and finally a fix from April 6th 2024...

And double-taxation has acted as a further disincentive for businesses to engage contractors, encouraging risk-averse practices like limited company contractor bans.

Following some protest to HMRC and HM Treasury, some good news emerged. At long last, the government agreed to introduce a legislative fix to solve this problem -- a very welcome development, and it will take effect from April 6th 2024.

While HMRC has been aware of the ‘double taxation’ ever since the rollout of the off-payroll working rules, the mechanics of it are complex. As a result, for many businesses, it’s a cause of confusion and concern.

What does this double taxation currently look like?

So-called ‘double taxation’ occurs when HMRC deems that a contractor has been incorrectly placed outside IR35 by an end-user business.

In these instances, HMRC doesn’t offset the tax already paid by a contractor when issuing a business with a tax bill for non-compliance. The tax office collects more than it’s actually owed -- hence the phrase, ‘double taxation’.

It’s easier to look at a possible sequence of events to see how it might play out in reality:

1. A contractor is engaged ‘outside IR35’ by a business

The end-client is responsible for determining IR35 status. For this engagement (in this example), the contractor is placed ‘outside IR35.’

The contractor completes the work and collects their fee. In due course, they pay their taxes.

2. HMRC investigates the end-client business

As part of its routine IR35 compliance activity, HMRC opens an investigation into the end-client -- scrutinising the accuracy of the IR35 determinations carried out.

3. HMRC finds the business has incorrectly engaged the contractor outside IR35

Following its investigation, HMRC deems the contractor provided their services in a manner akin to an employee.

As such, they should have been operating ‘inside IR35’ – meaning the contractor’s fee should have been subject to PAYE deductions before they received it, as well as subject to both Employer and Employee National Insurance Contributions.

4. The fee-paying party issued a tax bill for missing employment tax

Under the off-payroll working rules, the fee-paying party is responsible for the PAYE liability. Where there are two parties -- the end-client and a contractor -- the end-client is also the fee-payer. But if the end-client engages a contractor through a recruitment agency, the recruitment agency is typically the fee-payer.

Regardless, one of these two businesses would be issued a tax bill for the PAYE liability. But…

5. This bill does not offset the tax already paid by the contractor

When HMRC opened its compliance check, the contractor will have already paid tax (or will in due course) on the fee. This hasn’t been accounted for by the tax authority, which means…

6. The end-client business is, therefore, overtaxed as a result

HMRC collects too much tax from the end-client business. Under PAYE, as well as deducting Income Tax and Employee NICs from the fee, the end-client should also pay Employer NICs and, if they qualify, the Apprenticeship Levy.

As you can see, it’s a bit of a mess. Fortunately, this will change from April 6th 2024.

And what will IR35 /the off-payroll working look like from April, under this ‘offset?’

Instead of receiving an inflated tax bill, businesses will benefit from HMRC’s ability to offset amounts of tax already paid by a contractor and their intermediary against the PAYE liability.

Currently, achieving this is “administratively burdensome, resource intensive and costly for HMRC, deemed employers and workers”, and that’s in HMRC’s own words!

But from April 6th 2024, HMRC will use a combination of “assumptions and best judgement” to reach an estimated value of taxes already paid by the contractor, including “relevant tax return data”. Deductions will include:

• Corporation tax, paid by the contractor’s intermediary
• Income tax and Employee NICs paid to the contractor via their intermediary
• Class 2 and Class 4 NICs
• Tax on dividend payments

This list of deductions is comprehensive, and the calculations and assumptions will make the deduction as precise as possible. There are, of course, some caveats.

The change won’t apply retrospectively. Liabilities settled before the effective date are off limits, so businesses that have already been stung won’t be able to claim relief on amounts they’ve already paid.

Offsets also won’t include Employer NICs or the Apprenticeship Levy -- businesses will still be on the hook for those costs.

Looking hopefully to the horizon

Double-taxation has been an understandable cause for concern.

HMRC’s engagement with industry bodies to solve it -- based on open dialogue and a willingness to listen -- signals a potential shift in thinking at HMRC. Hopefully, this will continue.

In the meantime, the change will alleviate the concerns of businesses who feared excessive financial punishment for getting IR35 status determinations wrong.

Removing the risk should incentivise businesses to engage limited company contractors (also known as Personal Service Company contractors) once more. Perhaps I’m an optimist, but I’m of the view that the April 6th 2024 changes to IR35 -- the offset -- will encourage risk-averse businesses to rethink PSC contractor bans, too; we know that businesses can compliantly engage contractors outside of IR35. Now there’s one less barrier in the way.