IR35 tax loss insurance – what contractors really need to know


Since the Government first proposed the new Off-payroll working ("OPW") rules, some insurance firms have tried to muscle in on the new territory to sell insurance offerings to protect clients' and agencies' potential tax liabilities. However, as recent Government findings and statements prove, some of these policies are void in law and are nothing more than snake oil. Further, if agencies or clients promote them to contractors, they can exacerbate the risk for all parties under longstanding tax avoidance legislation.

Key points:

  • There are two types of insurance policies: (1) those covering tax investigation costs and (2) “tax loss” policies, which cover tax liabilities.
  • It is not possible to insure against the deliberate non-payment of tax.
  • Any insurance policy where the purchaser does not have an "insurable interest" is void in law.
  • The new Off-payroll working rules (Chapter 10 of ITEPA) differ from the original IR35 Intermediaries Legislation (Chapter 8 of ITEPA).
  • Under the new Off-payroll rules (Chapter 10 of ITEPA), contractors do not have any tax risk and do not have any insurable interest.

Therefore, a contractor cannot buy an insurance policy under the new Off-payroll working rules to protect someone else's tax liability.

Further, if an agency promotes tax loss insurance to a contractor, the Managed Service Companies legislation could trigger, leaving the contractor with a personal tax liability, irrespective of the IR35 position.

What is "IR35 Insurance" anyway?

Historically, "IR35 insurance" tends to mean a legal expenses policy, which covers the costs a contractor's company may incur for defending their tax position if HMRC opens a compliance check against them for tax liabilities under the original Intermediaries Legislation (Chapter 8, ITEPA 2003). The original "IR35" has been in statute since April 2000 and still applies to contractors working for small companies.

These tax investigation costs policies are very standard, don't cost much to buy, and are sensible for all businesses, not just contractors. They typically cover circa £125,000 worth of tax investigation costs.

And remember, for contractors that are still working for small clients, the small companies exemption applies, which means the new Off-payroll rules are not in play, and the contractor still has the liability.

Contractors who are members of IR35 Shield for Contractors enjoy our Tax Investigation Service, which combines £125,000 of cover and a defence delivered by the experts from IR35 Shield.

Off-payroll – who holds the liability?

The new Off-payroll working rules were introduced into the public sector in 2017 and then extended to medium and large companies in the private sector from April 2021.

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The new legislation requires companies to make determinations of the tax status of contractors operating via their own limited companies and for the tax to be deducted at source. Therefore, the liability for the tax now wholly sits with the client.

The tax liability wholly sits with the client because, unlike with the Intermediaries Legislation, there is no automatic offsetting mechanism in the legislation whereby the taxes already paid by the contractor can be taken into account and used to reduce the tax bill due by the client.

Two government bodies confirmed this in February 2022: The National Audit Office and HMRC themselves.

Factual confirmation by the National Audit Office

Many tax experts in the market had made representations to HMRC prior to April 2021 asking for them to include an offsetting mechanism through a statutory instrument (SI). But the issue was never resolved.

This startling oversight by the legislators was one of the key findings published in February 2022 by the Government's National Audit Office in their report titled "Investigation into the implementation of IR35 tax reforms". The finding on page 10 of their report reads:

"It [HMRC] does not offset the total amount against any tax the worker or their PSC already paid and told us this was not allowed within the current legislation. This means that HMRC collects more tax in total than is due. Once the non-compliant client organisation accepts that its determinations were incorrect, the workers become entitled to claim back the tax that they and their PSCs have already paid. If they do, they in effect pay no taxes on that income because these are borne in full by the non-compliant public body." [Emphasis added]

If HMRC successfully overturns an Outside IR35 determination, then the client pays all the tax, and the contractor gets a tax refund. The contractor has no liability.

Factual confirmation by the CEO of HMRC

A meeting by the Public Accounts Committee on 21st February 2022, attended by both Jim Harra, the Chief Executive and First Permanent Secretary of HMRC, and Nicole Newbury, the Director for Wealthy and Mid-Sized Business Compliance. Newbury confirmed the position:

"We do not have any legislative capacity to set off the amount paid by the personal service company or the contractor, so we collect the full amount from the public sector body. What then happens is that the individual contractor and their personal service company can make a claim for repayment." [Emphasis added]

To restate the same fact: the contractor has no liability under the new Off-payroll working rules.

Association of British Insurers: Insurable interest

One of the critical tenants of insurance law is that for a policy to be valid, the purchaser of the policy must have "insurable interest", as explained by the Association of British Insurers:

"The interest that a person has in something such as a particular property or another individual, which means that the person would suffer a loss should that property or individual be harmed.In insurance law, you can only buy insurance for something or someone in which you have an insurable interest." [Emphasis added.]

A simple way of understanding this basic premise is this: Your neighbour cannot insure your house if it burns down, nor can you insure them to drive their car.

For this straightforward reason, contractors cannot insure the client or agency under the new Off-payroll working rules.

Why the contractor cannot insure the client

Confirmation of the fact the contractor holds no liability, as confirmed in statements made by the National Audit Office and confirmed by the CEO of HMRC on record at the Public Accounts Committee, along with the standard fact stated by the Association of British Insurers only leads to one conclusion:

Any insurance policy bought by a contractor that purports to insure the client or agency against tax liabilities under Off-payroll working cannot possibly work and is highly likely to be void in law.

An insurance company that knowingly tries to sell void insurance policies is likely to breach the codes set by the Financial Conduct Authority.

Also, be mindful that signing an indemnity in a contract to pay someone else’s tax bill does not create the insurable interest necessary to make an insurance policy valid. This is because the indemnity is a contractual liability, not a tax liability.

Another point to consider is that claimants of insurance policies and the underwriter themselves with seek to subrogate their losses – that means sue other third-parties for negligence that brought about the loss. If you are a contractor, this means you are effectively buying a policy, that encourages a third-party to litigate against you – not a smart move.

But, it gets even worse for the contractor when considering the Managed Service Company legislation.

Managed Service Company legislation

The Managed Service Company legislation is tax avoidance legislation introduced in 2007 to combat large scale abuse of the tax system by companies that set up and controlled personal services companies for contractors.

If a contractor is found to be a Managed Service Company ("MSC"), then further tax liabilities are due, irrespective of the IR35 status of the engagement. And, due to brutal debt transfer rules, the liability passes to the contractor personally.

The legislation targets firms that carry on a business of promoting or facilitating the use of personal service companies. But the widely drafted clauses also bring into the net firms that promote tax loss insurance.

Our article dated 21st February 2021 warned that agencies touting IR35 insurance should consider the Managed Service Company Legislation.

What should contractors do?

Contractors should not buy any tax loss based insurance policy that purports to protect another party under the Off-payroll working rules. The key reasons are:

  1. It is highly likely to be void in law.
  2. The MSC legislation could make the contractor personally liable for extra tax.
  3. Any client who fails reasonable care is likely to be negligent, and an insurer won't pay out anyway.

The best way of approaching the new Off-payroll working legislation is robust compliance. It's a compliance problem, not an insurance problem.

Become a member of IR35 Shield?

For contractors that are still working for small clients, the small companies exemption applies, which means the contractor still has the risk. Similar exemptions apply for contractors providing services for wholly overseas companies.

Contractors subject to the old rules can become members of IR35 Shield for Contractors and enjoy our Tax Investigation Service, which combines £125,000 of cover and defence delivered by IR35 Shield experts.

IR35 Shield

IR35 Shield is the cloud-driven industry leading IR35 compliance standard for business and individual contractors.