Welcome changes to IR35 rules will introduce set-off mechanism to prevent overpayment of tax

Since changes to IR35 rules for off-payroll workers came into force there have been some ups and downs. However, from 6 April 2024, a proposed new set-off mechanism should prevent end user clients from overpaying tax where HMRC decides there has been a misclassification under the IR35 rules, bringing an individual back within scope of the rules.

What is IR35?

IR35 is a set of rules that apply to workers or contractors who work through an intermediary such as a personal service company (PSC). They make sure that workers, who would qualify as employees if they worked directly for the client, pay the right amount of tax and national insurance. 

Where an individual is out of scope of IR35, they are responsible for their own tax and national insurance and can reap the tax benefits of self-employment, including relevant corporation tax rates.

If an individual is in scope, they are treated as an employee and the end user client is responsible for paying their tax and national insurance.

What’s the issue?

Currently, in circumstances where HMRC decides there has been an incorrect classification of an individual which brings them back in scope of the IR35 rules (creating a subsequent liability for the end user client to pay tax as if the individual was a worker), there is no mechanism which allows them to offset any payment of taxes that have already been paid by the individual’s PSC. This can lead to double payment of tax. 

Whilst there is a process in place for the affected contractor to claim back the tax paid to HMRC, the process can be complex, and it is unclear how many contractors have actually done this in practice.

What's changing?

To prevent this issue, the government has proposed that, from 6 April 2024, a new set-off mechanism will be put in place – enabling end user clients to offset tax already paid by the individual’s PSC.

Specifically, the end user clients will be able to offset the following: 

• Corporation tax paid by the PSC on the income from the off-payroll working engagement
• Income tax paid on relevant earnings from the intermediary and dividends from their PSC. However the offset will only apply to income from the off-payroll working engagement
• Employee National Insurance Contributions paid on any salary to the individual from the PSC 

The offset will only apply to income from the off-payroll working engagement and it is proposed that employer NICs and class 3 NICs will be excluded.

The new rules will apply to income tax and NICs assessed on the end user client on or after 6 April 2024, for incorrect payments dating back to 6 April 2021 (when the rules came into force for large and medium employers) and 6 April 2017 for public sector organisations.

Our view

This is undoubtedly welcome news for companies who engage off-payroll workers or have to date been afraid to use them because of the complex rules and double taxation risks. We may start to see a rise in such relationships, but time will tell.

We can help

Whilst this is an important step towards simplifying the process, there are still ongoing risks to be aware of. It is still hugely important to keep under review the relationship you have with any contractors etc to ensure that they still fall within (or outside) the rules of IR35 and that you have legally compliant and accurate contracts and policies in place. 

We have a huge amount of experience in dealing with IR35 and can help you with any stage of the process. We are able to offer a competitive fixed fee for an IR35 team (comprising both an employment lawyer and tax expert) to:

• Review an individual’s working practices and provide a traffic light report showing where there are risks and whether the engagement falls inside or outside of IR35
• Review your contracts (or prepare one if you have none in place), and suggest amendments or further clauses to protect your position
• Prepare a status determination statement and information to be sent to the worker and any intermediaries
• Provide training on IR35

Please contact Padma Tadi-Booth for more information.