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IR35 legislative tweak to remedy settlement offset issue by April 2024

Long-standing issue with how IR35 rules work to be resolved in April, thanks to Finance Act change

A tweak to how the IR35 tax avoidance legislation works means that from 6 April 2024, HM Revenue & Customs (HMRC) can no longer be accused of over-collecting tax from non-IR35 compliant public and private sector organisations.

The change means that when HMRC calculates how much tax is owed by a public or private sector organisation that has fallen foul of the IR35 rules, the amount of corporation and dividend tax its contractors have already paid will now be factored in as well.

Previously, this was not the case because HMRC had no legislative means within the IR35 rules of offsetting the tax the affected contractors may have already paid, but a change to the Finance Act 2024, which received Royal Assent on 22 February 2024, has now rectified that.

What are the IR35 reforms?

The IR35 reforms were first introduced to the public sector in April 2017, before being extended to medium-sized and large private sector firms in April 2021, and saw contractors cede control of determining how they should be taxed to the end-user organisations that engaged them.

Previously, contractors were able to self-declare whether the work they do, and how it is performed, meant their engagements were in or out of scope of the IR35 rules, but – according to HMRC – this system was being abused by some to deliberately misclassify themselves as working outside IR35 and artificially minimise the amount of tax they pay.

This is because engagements that were classified as being inside IR35 meant the contractors concerned would be treated as employees for tax purposes and expected to make the same pay-as-you-earn (PAYE) and NICs as permanent employees.

The roll-out of the changes to both public and private sectors brought about huge amounts of upheaval for IT contractors as some end-hirers sought to side-step the additional administrative burden this shift in responsibility put on them by introducing contractor hiring bans.

Other organisations decided to issue blanket determinations, whereby all contractors were deemed to be working inside IR35 as a means of ensuring compliance and to reduce the risk of being saddled with a sizeable tax bill later down the line for incorrectly assessing the tax status of their contractors.

To this point, several central government departments have found themselves subject to compliance reviews by HMRC that have seen them hit with penalties and multimillion-pound tax bills for making IR35 status determination errors.

“Since 2017 [when the IR35 reforms came into force], the potential for disproportionate tax bills threatened firms with tax bills four times the actual amount of underpaid tax due to the double-taxation flaw within the statute,” said Dave Chaplin, CEO of IR35 compliance firm IR35 Shield, who is one of a number of parties to have campaigned for several years to get this legislative change enacted.

“The one-page ‘offsets fix’ in Clause 17 of the Bill ensures any liability relating to incorrect IR35 determinations is now equitable, enabling businesses to operate without fear of unjust financial penalties,” he said.  

The change also mean contractors will no longer be entitled to claim back any tax they have previously paid to HMRC in instances where their end-hirers have been found to have made IR35 status determination errors.  

“The new rules only apply to settlements made after April 2024,” Chaplin told Computer Weekly. “Where there is existing enforcement action, which has not been settled, settlements had been paused by agreement, until the new rules came into place. Firms who settled before April 2024 won’t get any refunds.”

Read more about IR35

As previously reported by Computer Weekly, HMRC has been under pressure from various tax and contracting market stakeholders for several years to rectify this situation, which has been previously cited as a reason why contractors were finding it so difficult to secure outside IR35 engagements.

A representative from The Institute of Chartered Accountants in England and Wales (ICAEW) wrote to HMRC in August 2020. The letter – seen by Computer Weekly – stated: “ICAEW has been concerned for some time about offsets.”

The letter also set out a series of suggested workarounds that would require “no change to the [off-payroll] legislation to push through”.

The quarterly IR35 Forum, which is a group of external stakeholders that HMRC oversees who are tasked with finding ways to make the off-payroll legislation work more effectively, has discussed at multiple meetings throughout 2021 about how best to address the issue.

It was also flagged as a source of concern by the National Audit Office (NAO) in a February 2022 report about HMRC’s handling of the public sector roll-out of the IR35 reforms in April 2017.

Chaplin said news of the change will be a big relief to public and private sector organisations, and could accelerate the pace at which organisations are rolling back hiring bans and blanket inside IR35 determinations. “Prior to the offset fix, firms may have had to engage in protracted and expensive litigation via HMRC through the tax tribunals to seek the same fair outcome when settling amounts of tax for misclassification,” he said. “Now, it should be much simpler.”

“Many firms have been lifting blanket bans on contractors for quite a while now, for commercial reasons. Where firms still have blanket bans in place for fear of excessive tax risk, they may revisit that policy if they find themselves having challenges competing for talent against their competitors.”

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