Off-payroll working: Offsets issue being fixed with retrospective effect


A fix to the "IR35 Reforms" Off-payroll legislation (Chapter 10 ITEPA 2003) will feature in the Finance Bill 2024 and apply retrospectively to all engagements from 06 April 2017 to ensure that where firms incorrectly classify workers, any corrective action by HMRC results in tax bills being shared equitably between the deemed employer and worker.

The current regime prevents the same income from being taxed twice by HMRC and ensures the hiring firms do not unfairly get saddled with tax bills over four times what they should be.

The announcement was made in a short consultation document published by the Government titled: Off-payroll working (IR35) – calculation of PAYE liability in cases of non-compliance released on 27 April 2023.

The consultation, which recommends a single straightforward solution, and rules out any other options, will run for eight weeks, followed by a response later in 2023 and a change to primary legislation in Finance Bill 2024.

Given that the matter has been widely discussed between stakeholders and HMRC for the last five years, this light canter through the five steps of the Tax Consultation Framework is essentially a tick-box exercise.

What are the off-payroll changes happening?

In short, where HMRC discovers that a directly engaged worker has been incorrectly classed as "Outside IR35" instead of "Inside IR35", an offsetting mechanism would be used similarly to existing provisions in the PAYE Regulations 2003 (SI 2003/2682), that can allow the setting off of taxes already paid by the worker and their limited company.

The taxes that can be offset will include the corporation tax paid, national insurance paid, and any income taxes paid on dividends.

Due to the increase in corporation tax and the dividends taxes over the years, the amount of tax a worker pays on their earnings when channelled via a limited company is roughly equal to the taxes paid by an employee on their salary. Therefore, as a general rule of thumb, an IR35 tax bill under the new regime, where offsets are fully applied, will roughly equal the employer's National Insurance bill due.

Who will the new IR35 offsetting changes affect?

These changes are only relevant when an HMRC investigation discovers that a worker using an intermediary under off-payroll rules has been incorrectly determined as "Outside IR35" instead of "Inside IR35".

Hiring firms who have got their IR35 determinations right are not affected.

For firms who have got determinations wrong, this will be a welcome reprieve, resulting in potential tax bills reduced by approximately 75%, roughly equating to an employer NIC charge on top of the workers they hired. The overall tax collected by HMRC is the same; it's just that the same monies are not taxed twice.

The offset fix makes no financial difference for contractors because they are not liable for any taxes under the new IR35 rules.

For recruitment agencies, in the unlikely event they get saddled with a tax bill, the tax offsets mechanism will also apply, where the more equitable application is used.

As outlined in the consultation, the financial impact on the Treasury is "Nil", because the same amount of overall tax is still collected.

Will this help the UK's flexible workforce?

Due to the legislative flaw, a disproportionate tax risk of over four times the actual tax due was a significant concern for firms who adopted governance policies of a high-risk nature when hiring flexible labour, leading to blanket banning of the use of contractors.

However, banning contractors can, in some cases, restrict access to the best on-demand talent in the workforce, unless a considerable premium is paid, particularly for workers who need to travel to remote sites and incur expenses.

Whilst there was a "blanket ban" by firms in the early days of the Off-payroll legislation, this was also driven by the practicalities of the challenges they faced – for many firms, understandably, pressing the reset button was the sensible choice. Some will also have been waiting for the more equitable offsetting issue to be resolved before engaging contractors again.

Some firms may revisit current blanket bans and choose to implement an assessment regime, using firms like IR35 Shield, but the market is unlikely to shift to a pre-April 2017 position. According to the consultation, the estimates by HMRC also don't predict material changes either.

When will the offsets rules become law?

Given all the main stakeholders have discussed the matter with HMRC at length for years and designed the mechanism in conjunction with them, firms can take comfort that this is essentially a done deal.

The fix will be enacted in Finance Bill 2024 and be retrospective from April 2017.

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