HMRC are set to tackle IR35 double taxation

Could an ongoing HMRC consultation see at least one of the inequities of IR35 banished? June 22nd 2023 is the closing date of an open HMRC consultation of particular interest to all parties in the labour-supply chain. It invites responses to HMRC’s proposals to tackle the ‘double taxation’ which exists where errors have been made in applying the off-payroll working rules.

Under current legislation HMRC are unable to take into account a ‘set off’ of any tax and National Insurance Contributions (NICs) already paid by a PSC and worker when calculating the PAYE/NICs payable by a ‘deemed’ employer.

The result is that the deemed employer accounts for its liability in full and the PSC/worker may be entitled to various refunds of Corporation Tax (CT) and NICs. Effectively the deemed employer bears all of the cost of the worker’s tax burden with the worker bearing none of it.

Here’s an example from HMRC of the problem:

• Client engages a worker through their PSC and agrees to pay £50,000 for the service. Worker is assessed by the client as being outside IR35 and the £50,000 fee is paid gross.
• PSC pays worker with salary up to NIC Class 1 primary threshold (£11,908 for 2022/23) and the rest as dividend. PSC assumed to have no other income or business expenses.
• PSC pays Corporation Tax (CT) on business profits and worker pays tax (IT) on dividends.

However, HMRC will already have collected £7,160 of CT and £404 of employer NICs from the PSC and £2439 of IT from the worker on dividends (assuming worker’s personal allowance already exhausted by other income).

As the client is liable to pay the full amount of IT & NICs due under PAYE, HMRC will have collected an additional £10,003 tax and NICs on the engagement more than was due.

The proposed solution to this issue of over-collecting tax in cases of non-compliance as set out in the consultation by HMRC has a number of prerequisites including:

• It needs to incentivise compliance and encourage clients to take reasonable care in making the correct status determinations;
• The amount to be set against the deemed employer’s PAYE liability must be calculable, exactly or roughly, using information available to HMRC;
• The solution should share the tax burden more equitably between deemed employer and worker;
• Administrative burden of implementation for HMRC and taxpayers should be minimised.

The consultation goes on to describe the changes to both existing legislation and practices needed to devise a workable solution and seeks stakeholder views on options to bring about the ‘set off’ of tax liabilities between different parties including:

• The taxes which would be in scope including CT paid by a worker’s PSC on the income from the engagement; IT and employee NICs paid on a salary to the worker by his PSC and tax paid on dividends which arise out of income from the off-payroll working engagement.
• How assumptions and best judgement would be needed to estimate the amount of tax paid by a worker and their intermediary (PSC). The use of actual Tax Return data and the possible use of historic patterns of behaviour and tax receipts to arrive at a reasonable figure.
• The use of direction notices and an appeal process seen elsewhere in the PAYE regulations to establish the amounts of set-off.
• The range of information needed to trace workers/intermediaries on HMRC’s systems.

The contracting industry has generally welcomed the initiative by HMRC to address this particular issue. However, it continues to make the point that the whole of the IR35 regulations are not fit for purpose in the modern working world.

Unfortunately, that battle has to be fought outside the remit of this consultation which has been explicitly explained by HMRC as not being the forum for reform or revisiting how employment status is determined. The questions asked are focused on matters relating purely to the set-off issues.

As things stand this consultation will hopefully serve to develop a compromise solution which should translate into reality some time after 5 April 2024. Long overdue, but welcome nonetheless.