A row of wooden figures with one standing apart - businesses use contractors to access special skills.

IR35 Update

Posted on 26th July 2024

If you work as a contractor, you might work through an intermediary. This could be a limited company, a partnership, or through your own personal service company (PSC). This is known as off-payroll working.

Many businesses choose to use contractors as a flexible option and to access specialist skills.

However, if His Majesty’s Revenue and Customs (HMRC) thinks contractors are really employees it can have a big impact. Contractors’ net income might go down by 25% due to additional income tax and National Insurance Contributions (NICs). Businesses could also face charges for a contractors’ Pay As You Earn (PAYE) tax and National Insurance Contributions (NICs).

What is IR35?

Tax rules known as Inland Revenue 35 or IR35 have been around for over 20 years. They’re designed to make sure anyone deemed an employee pays broadly the same tax and NICs as other employees. Ever since they were introduced, tax experts have raised concerns about these rules. They highlighted the costs and difficulties they can cause for both contractors and small businesses.

How does IR35 work?

It’s a challenge, especially for small businesses who use contractors, to know whether the IR35 rules apply.

Generally, IR35 comes into effect when someone would be treated as an employee if they weren’t working through a PSC. This means an organisation:

has control over how work is completed such as working hours and where the work must take place

is obliged to give someone more work once they’ve finished a task and they must do the work.

If businesses incorrectly treat contractors outside the IR35 rules they risk significant financial penalties. Until April this year, there was also a ‘double taxation’ problem.

Double taxation happens when HMRC believes a contractor was incorrectly treated outside of IR35. A tax bill is then issued to the business using their services for employee PAYE and NICs. HMRC doesn’t offset this against any tax the contractor has already paid. The contractor also pays taxes equivalent to an employee. As a result, both pay additional taxes.

How is the double taxation problem solved?

HMRC has now changed its approach. It will use a combination of ‘assumptions and best judgement’ to estimate the tax already paid by a contractor. This might include:

Corporation Tax already paid by an intermediary

income tax and NICs paid via an intermediary

Class 2 and Class 4 NICs

tax on dividends.

The changes will make commissioning contractors more attractive for small businesses by taking away many IR35 tax risks. Unfortunately, businesses can’t claim relief on any double taxation already paid. The offsets won’t cover Employer NICs or the Apprenticeship Levy, so some costs can still arise. However, overall tax bills due to IR35 mis-determinations could go down by 75%.