June 15, 2023
The off-payroll working rules (commonly known as the ‘IR35 rules’) were first introduced in 2000. The rules require that where an individual is working like an employee, they must pay tax like an employee – regardless of whether they are working through their own intermediary (for example, a personal service company or ‘loan-out’).
Controversial from the outset, the IR35 rules continue to evolve. HMRC has launched a consultation (accessible here) which seeks to address one of the contentious aspects of the rules, i.e. the settlement of tax liabilities that arise under the rules when contractors have been incorrectly determined as self-employed.
Under the current rules, if a production has incorrectly determined the employment tax status of its contractors, then (unless it is a small private company) it is held liable for all income tax and National Insurance contributions (‘NICs’) that should have been deducted via PAYE from payments to the contractor. In this situation, HMRC could collect more tax than is due if the contractor and their intermediary have already paid tax and NICs on the same income in the belief that they were self-employed. Whilst the contractor and their loan-out would be entitled to claim a refund for any corporation or income taxes paid by them, this is subject to time limits and conditions and may not happen in full in practice. The issue has been raised by stakeholders and highlighted by the National Audit Office and Public Accounts Committee, who published reports in early 2022.
The consultation therefore aims to reduce any such ‘double taxation’ and bring the rules for contractors operating through their own intermediaries in line with those which already exist for direct hires (where the production would only be required to pay income tax not already included on the contractor’s self-assessment tax return or accounted for under the construction industry scheme).
What do you need to know?
1. The set-off proposal
The consultation proposes a ‘set off’ mechanism to estimate and then deduct taxes already paid by the contractor or their loan-out in relation to the same income from the income tax and NICs liability assessed by HMRC on the production, aka the deemed employer. The amount that could be set-off would include the below to the extent it relates to income from the engagement:
- corporation tax paid by a contractor’s loan-out;
- income tax and employee NICs paid on a contractor’s salary from their loan-out;
- class 2 and 4 NICs paid by the contractor, where the contractor’s intermediary is a partnership; and
- tax paid on dividends received by a contractor from their loan-out.
If the government proceeds with the proposals set out in the consultation document, it intends to introduce the relevant legislation from 6 April 2024.
Overall, this seems a pragmatic solution to simplify the process and reduce potential double taxation, by removing the requirement for a production to bear the full cost of the income tax and NICs liability where some tax has already been paid on that income.
The principle behind the proposal is sound, i.e., to find a solution which more equitably divides the tax burden between the deemed employer and the contractor. If successfully enacted, these changes should be a significant improvement on the current position since it should reduce the burden of employment tax on the production when deemed to be an employer and the strain on contractor relations from any resultant indemnity claim against a contractor.
The complexity of the situation inevitably means that the solution is less than perfect.
1. No set-off would be available for:
- employer NICs paid by the loan-out on any salary paid from the loan-out to the contractor; or
- tax or NICs paid by other employees, directors, or shareholders of the loan-out.
2. Any offset would be based on an estimate of the tax already paid by the contractor and their PSC. An estimate is an estimate and by its very nature may be inaccurate.
3. Admin burden on businesses: HMRC’s ability to apply a set-off will depend on whether they can trace the contractor’s and/or their PSC’s records on HMRC’s systems. To facilitate this process, HMRC would need to obtain as much information as possible from the deemed employer in respect of the contractor and their PSC (or other intermediary). This could include but is not limited to:
- the contractor’s name and address;
- the contractor’s date of birth;
- the contractor’s National Insurance Number;
- the intermediary’s name and address;
- the intermediary’s VAT Registration Number or Company Registration Number.
Whilst most productions will have processes in place to review the employment tax status of their contractors, many will not be obtaining the full suite of information regarding such contractors and their loan-outs that HMRC will require for any future offsetting.
4. Where a penalty is charged, the amount of the penalty will be calculated on the full income tax and NICs liability, rather than the amount of tax outstanding after any offset has been applied. The consultation is currently unclear on whether interest would also apply to the full tax liability, which could be increasingly material given the current interest rate environment. HMRC’s current interest rate for late payment of tax is 7%, up from 3.5% this time last year.
What do you need to do?
The consultation is high level and leaves some critical details to be worked out. Based on the information available, however, organisations can take active steps now to safeguard their position:
1. Respond to the consultation with any specific concerns. The consultation will close on 22 June 2023. You can respond to the consultation directly by emailing email@example.com or, if you would prefer, you could email us here with a view to feeding into our response.
2. In order to benefit from the proposed offset, you should:
- have robust processes to rigorously assess the employment tax status of your contractor workforce and thereby reduce the risk of HMRC successfully challenging their tax status;
- collect and store the contractor data required by HMRC to facilitate an offset of tax under the proposed rules (noting that this will most likely be in excess of what is collected as part of a standard onboarding process of a self-employed contractor via a loan-out); and
- review your existing contractors to check their status (if not done already) and to update their data to aid any future offset of tax in the event of a future HMRC challenge.
IR35 Manager clients
Please note that the platform allows companies to meet all of the above recommendations – in particular, in respect of ensuring that the production is able to collect the data required by HMRC to identify the contractor’s information on their systems and therefore benefit from the set-off mechanism (according to the current consultation). Please contact us should you require any further information.