A loophole which forced thousands of contractors and businesses that fell foul of IR35 rules into paying more tax than they owed has finally been shut.
From April 6th, HMRC has formerly rolled out an offset mechanism which takes into account tax already paid when calculating liabilities under IR35.
Previously, if a contractor was deemed to be working ‘off payroll’ when they should have been paying Income Tax, they and the company that hired them faced being hit with a bill for the full amount of tax owed for the relevant period, without accounting for any tax already paid.
This ‘double jeopardy’ is the latest in a long line of issues that has dogged government efforts to clamp down on off-payroll working.
From one loophole to another
Off-payroll working describes a situation where a person is deemed to all intents and purposes to be working as an employee of a business, for example by working fixed hours on fixed terms set by the company. But instead of being on the payroll and treated as an employee for payment and tax purposes, the individual provides services as a contractor via an intermediary entity, be it their own limited company, a partnership, or via another individual.
This has long been recognised as tax loophole HMRC has been keen to shut down. Individuals providing services via a limited company, for example, could take advantage of the fact that Corporation Tax rates are lower than Income Tax to pay less than they would if employed, while hiring firms could avoid employment taxes like NIC contributions.
The original IR35 legislation aimed at stamping out the practice was passed as far back as 2000. But enforcement was dogged by difficulties in defining what did and did not constitute off-payroll working versus legitimate contract work. Individual cases got dragged into the courts and the legal wranglings in effect made the original IR35 legislation unworkable.
The 2017 Finance Act revived the clampdown, initially in the public sector only, with a new set of definitions and protocols. This included making the hiring company/organisation responsible for determining IR35 status and deducting the correct taxes accordingly, rather than the contractor/intermediary company. This came into force for all private companies in 2021.
Freelancers and self-employed workers feared a chilling effect on contract work. Rather than take a risk, or even take on the burden of having to check employment status under IR35 rules, it was argued many businesses would just avoid hiring contractors altogether.
But it soon became apparent there was another problem. When HMRC ruled that a contractor had, in fact, been working ‘inside IR35’ as what legally counted as an employee, it would calculate the Income Tax and NIC accrued retrospectively for the entire period of the relationship. The parties involved were obliged to pay the full amount.
But hiring firms and contractors flagged up that they had in fact been paying tax for the duration of the relationship, albeit at a lower rate. There wasn’t any mechanism to account for this in HMRC’s calculations, so businesses and contractors were in effect being double charged.
Now that loophole – which was to the benefit of HMRC this time – has been closed, it’s hoped there can finally be some clarity and stability around the murky issue of IR35,
If you have any further questions or concerns around IR35 or any other aspects of employment law and compliance, please contact our Payroll team below.
