Understanding IR35 reforms and impact on contractors

The world of taxes can be a complicated and challenging place to traverse. One such part of this complex landscape is the legislation surrounding off-payroll working, also known as the IR35 legislation, which has been causing significant confusion and concern. HMRC’s recent proposal to change the way contractors are taxed under this scheme has only stirred up more uncertainty. ContractorUK attempts to break it all down and help you understand what’s going on.

Decoding IR35: What’s causing double taxation for contractors?

A system that started out promising to be a fair way to tax contractors has ended up with an unintentional outcome: double taxation. The crux of the issue lies in Chapter 10 Part 2 of the Income Tax (Earnings and Pensions) Act 2003 (ITEPA) legislation.

This legislation stipulates that the HMRC will investigate the ‘end client’ (the entity hiring the contractor) if it suspects a misapplication of the IR35 rules. If the HMRC decides a mistake has been made, they would demand that the client pays tax on the full amount they paid the contractor, without acknowledging any tax paid by the contractor. This overlooks the fact that the contractor’s private limited company would have already paid corporation tax on the same funds, effectively causing a double taxation.

The predicament of a contractor: Making payments under the current framework

As a contractor, you know only too well that, on top of this complication, tax must be paid no matter how funds are extracted from your limited company. The tax already paid by the contractor, their company and employees is not currently accounted for when determining the tax liability of the deemed employer by HMRC.

HMRC carries out its investigation, collects any due tax with additional levies from the client, and then informs the contractor of a potential refund. However, the process grinds to a halt if HMRC doesn’t possess accurate contact details, leading to scenarios where too much tax is collected and no refund is processed. It’s therefore essential that contact details are kept up to date to not miss out on any refunds, especially considering these refunds have a time frame attached and won’t be handed out if the contractor is “late to the party”.

Prospective changes: Adjustments to the IR35 offer

A more balanced tax scenario could be on the horizon, following a recent HMRC consultation, which closed on June 22nd 2023. The proposed structure would allow Corporation Tax, Income Tax, National Insurance Contributions (NICs) and any tax paid on dividends to be set off against the client’s PAYE liability.

This would effectively mean, there would be no direct refund to the contractor, but instead, the client’s tax bill could be significantly reduced. This may seem unfair to a contractor, but if you consider yourself akin to an employee, the tax responsibility would typically lie with both the employer and the employee.

It’s been revealed that this new system could take effect from April 6th, 2024, providing a potential tax respite for deemed employers. It’s been reported that HMRC has given organisations a chance to ‘pause’ any ongoing IR35 enquiries until this new system is in place.

HMRC’s offer: What’s the Catch?

However, you must meet specific criteria for this “pause” to happen. You must admit to making a mistake in applying the off-payroll working rules in writing and agree with the gross liability. You will also need to provide specific information about the contractor and their company.

While this movement by HMRC relieves some of the administrative burdens, it doesn’t offer an offset for both Employer’s National Insurance paid by the contractor or Tax and NI payments made to employees/shareholders who are not included in the supply chain.

In the last two years, we’ve seen a series of tax and NIC indemnity clauses spring up in contracts between recruitment agencies and contractors, affecting direct relationships between contractors and their clients. While these indemnity clauses are still somewhat ambiguous in their enforceability, the new offset provision could provide reassurance to clients who were fearing they could be left to cover the entire tax liability alone.

However, it is significant to note that this new provision may not fully eliminate the HMRC liability. It’s probable that there may still be a taxed amount, along with additional interest and penalties left to pay. As always with tax matters, the devil is in the detail. But remember, understanding the detail is your most reliable defence against finding yourself lost in the tax maze.