The Conservative Government has finally announced an imminent fix to the legislative double-taxation" flaw in the Off-payroll legislation, which will apply retrospectively from 06 April 2017, ensuring firms do not end up saddled with unfair tax bills over four times what they should be.
The plans were outlined in a short consultation document titled "Off-payroll working (IR35) – calculation of PAYE liability in cases of non-compliance", released on 27 April 2023. The consultation, which recommends a straightforward solution, will run for eight weeks, followed by a response later this year and a change to primary legislation in Finance Bill 2024.
Dave Chaplin, CEO of IR35 compliance firm IR35 Shield says: "Firms currently under HMRC's radar can take considerable comfort that the offset fix will be retrospective, all the way back to April 2017. The consequence means any bills already issued and not settled will be reduced by approximately 75% - to align with the correct and fair amount of tax owed."
What was the IR35 offsets problem?
The core problem occurred if HMRC intervened when they considered that the client had misclassified status. In that instance, the hiring firm bore the entire tax bill for themselves and the worker, whilst the worker ended up with a tax refund and paid no tax.
The acknowledged unfairness in the legislation was highlighted in the consultation, which described the current process: "This [current process] results in the deemed employer bearing all of the cost of the worker's tax burden, with the worker bearing none of it."
Chaplin says: "The double-taxation flaw in the off-payroll rules was grossly unfair on businesses who were being threatened with tax bills more than four times the perceived underpayment of tax."
The new policy will remove the unfairness and is explained as "apply[ing] to Income Tax and NICs liabilities assessed on or after 6 April 2024 which arise as a result of an error in operating the off-payroll working rules in respect of deemed direct payments made from 6 April 2017, when the public sector reform was introduced."
Offsets unfairness – an example
Under the current rules, a firm hiring a contractor for 12 months and paying them "Outside IR35" of, say, £100,000, which HMRC later claimed was wrong, would be given the following tax bills:
- Employee tax deductions of £32,950 [Employees NI £5,518 and PAYE of £27,432]
- Employers NI (on top of £100K): £12,544
- Total: £45,494.
But, in this instance, the contractor's company (assuming zero running costs for simplicity) would have paid corporation tax of £22,750 and dividend taxes of £12,230, a total of £34,980.
The difference between the tax paid and what HMRC argues should be paid is actually £10,515. But, under the existing rules, the client must pay £45,494, and the contractors' company can reclaim the entire £34,980 and keep it themselves, which is wrong. The alarming difference is due to the same money being taxed twice, which is unfair.
Under the new policy, which will apply retroactively from April 2017, instead of the hirer ("deemed employer") paying £45,494, in this instance, once offsets were considered, they would pay £10,515 - roughly 10% more on top of what they paid the contractor in the first case.
Ultimately, the new policy will achieve the stated policy objective to "…share the tax burden more equitably between the deemed employer and worker."
History and timeline of the offsets issue
The offsets issue has been a longstanding problem, raised by multiple stakeholders in the industry and directly with HMRC as far back as March 2018. A timeline of key events:
- 23 March 2018: ICAEW wrote to HMRC, raising the offsets issue.
- 21 May 2020: HMRC's IR35 Forum minutes note offsets issue.
- 21 August 2020: Offsets issue raised at the IR35 Forum, with a paper presented.
- 19 April 2021: The private sector members of the IR35 Forum write a joint letter of concern to the co-chair (HMRC) of the IR35 Forum, expressing concern over the offsets issue.
- 12 July 2021: IR35 Forum holds a meeting to discuss the offsets issue. Members are invited to send submissions on the issue.
- 03 September 2021: In the IR35 Forum meeting, HMRC acknowledged the points raised but chose to implement their proposal whereby the deemed employer bears the full impact of the tax liability.
- 27 September 2021: The private sector members of the IR35 Forum write to the Financial Secretary to the Treasury, Lucy Frazer, to express their concerns with HMRC's policy decision on tax offsets.
- 06 December 2021: Dave Chaplin meets with the National Audit Office and makes representations concerning the tax offsets issue.
- 02 February 2022: Publication by the National Audit Office, Investigation into the implementation of IR35 tax reforms, refers explicitly to the double-taxation issue.
- 11 February 2022: Dave Chaplin writes to the Public Accounts Committee to give evidence, stating one point - The offsets issue needs to be fixed.
- 21 February 2022: Public Accounts Committee (PAC hearing) – The head of HMRC admits there is an issue.
- 11 May 2022: PAC publishes a report which refers to the offsets issue as a structural problem.
- 05 December 2022: Treasury Minutes Report indicates agreement with PAC recommendation that HMRC should ensure that "HMRC does not end up taxing the same income twice."
- 07 March 2023: ContractorCalculator runs a mini "fix-or-ditch" campaign, seeking to bring about fixes, including the offsets issue. Conservative Home publishes an opinion piece.
- 27 April 2023: HMRC publishes consultation.
[Editors note: The list of events and stakeholders involved is not exhaustive – almost every trade body has raised the issue in the industry for years.]
Chaplin says: "Despite the claims in the consultation that HMRC engaged with stakeholders on this issue in 2021/2022, the reality is that HMRC has known about this problem since at least March 2018 and chose to do nothing about it. It wasn't until Parliamentarians were engaged that action has now happened."
What should firms and contractors now do?
For clients and contractors, it is essentially business as usual. The changes will mean that if they get an IR35 status determination wrong, they won't be hit with a disproportionate tax bill compared to the actual underpayment of tax.
Chaplin concludes: "Whilst this is labelled a consultation, the speed and narrow focus of the single solution reads like an announcement. The short consultation window of only eight weeks, followed by a response later this year, and commitment to legislate by April 2024 indicates that this is pretty much a done deal."