IR35: offset mechanism to be introduced for the off-payroll working rules

One of the most frequently asked questions from clients in relation to IR35 is what happens if HMRC disagree with the end user’s assessment that a contractor who is using a personal services company (PSC) is outside the IR35 rules. The short answer is that not only must PAYE and employee and employer national insurance contributions (NICs) be paid on the fees paid to the intermediary going forwards, but HMRC will also seek PAYE and NICs arrears together with interest and potentially penalties.

Buried in the Autumn Statement 2023 is the welcome announcement Off-Payroll Working (IR35) — calculation of PAYE liability in cases of non-compliance - GOV.UK (www.gov.uk) that an offset will be introduced, meaning that any corporation tax paid by the PSC on the fees from the end user can be offset in calculating the PAYE arrears on those fees.

What is IR35?

IR35 is a tax anti avoidance rule which applies where an individual provides their labour to an end user via an intermediary (such as a PSC or partnership). Under IR35 if the individual is a disguised employee – i.e. the individual would be an employee of the end user if hired directly by the end user – PAYE and NICs should be operated on the fees paid to the intermediary (excluding VAT).

Haven’t there been already several changes to IR35?

Yes. Concerned about non-compliance, HMRC made two significant changes:

• First, the responsibility for assessing whether a contractor using an intermediary is a disguised employee (subject to some limited exceptions) moved from the contractor to the end user. The end user must consider the contractor’s IR35 status using reasonable care and confirm its determination and the reasons for it in a “Status Determination Statement” which it must give to the contractor and the entity with which the end user contracts.
• Second, if the end user considers that the contractor is a disguised employee inside IR35, the liability for operating PAYE and NICs moved from the intermediary to the fee payer. The fee payer is the entity which has the direct contractual relationship with the intermediary.
  This means in a simple supply chain of: End User- PSC – individual contractor, the end user is also the fee payer. In a more complex supply chain involving a UK agency such as: End User – UK Agency - PSC – individual contractor, the UK agency is the feepayer and has the responsibility to operate PAYE and NICs.

These changes took effect in April 2017 in the public sector and in April 2021 in the private sector.

What happens if HMRC disagree with the status determination?

In those situations where HMRC consider that the end user has incorrectly determined that the contractor is outside IR35, arrears of PAYE and employee and employer NICs (potentially going back you to 6 tax years depending on the circumstances), interest and potentially penalties arise.

If there is no UK agency in the chain, the end user would be liable for these amounts.

If there is a UK agency in the chain, the position primarily depends on whether HMRC consider that the end user had complied with its IR35 obligations as follows:

• If there is no UK agency in the chain or HMRC consider that the end user had not used reasonable care in making its determination, the end user would be liable.
• If HMRC considered that the end user had complied fully with IR35 obligations and there is a UK agency in the chain, the UK agency would be liable.

Why is an offset mechanism needed?

Under the current legislation the end user or fee payer (as appropriate) must pay the full PAYE/NICs arrears and is not able to take account of any tax or NICs paid by the intermediary. However, in practice, it is likely that the intermediary will have already been assessed or paid corporation tax or income tax on those fees. In this scenario, the intermediary would be able to claim a refund from HMRC, and the end user or fee payer would be left trying to recover the PAYE and employee NICs arrears from the intermediary in accordance with any contractual indemnities.

This situation adds to the cost and complexity of operating IR35 and there has been significant lobbying for an offset mechanism to be introduced. This is particularly the case as there is an offset mechanism where a contractor supplies their labour as a sole trader - in this situation the engager can offset any tax and (self-employed) NICs paid by the contractor on the fees against its arrears on those fees.

What does the announcement say?

The announcement confirms that legislation will be introduced to allow end users/fee payers to offset an amount equal to HMRC’s best estimate of the corporation tax or income tax paid by or assessed on the intermediary in respect of the fees received from the end user against arrears of PAYE (and it seems NICs) assessed after 6 April 2024. The mechanism will be available for arrears going back to April 2017 (when IR35 was changed for the public sector).

The announcement is broad brush and, as so often with these measures, the devil is in the detail so careful analysis of the legislation will be required - but it’s definitely a step in the right direction.

For further details on other Autumn Statement measures, please see Matthew Rowbotham’s summary - Autumn Statement 2023: Everything’s absolutely whizzer, stop asking questions! And for further details on IR35 please see our inbrief.