New IR35 tax set-off mechanism should be retrospective, say experts

Penny Simmons and Steven Porter of Pinsent Masons were commenting on the  latest IR35 consultation opened by HM Revenue & Customs (HMRC), which looks at the  calculation of PAYE in cases of non-compliance. HMRC is consulting on proposals to introduce new rules allowing businesses to set-off PAYE taxes already paid by a worker and its intermediary in cases where HMRC determines that they have made an error in applying the IR35 rules and are liable for employment taxes and national insurance contributions (NICs) in respect of the worker.

Simmons said: “The consultation is a welcome development. There has been growing concern across industry about businesses being unable to set-off PAYE taxes already paid by a worker if HMRC considers that they have failed to apply the rules correctly and are liable for PAYE taxes, even though HMRC may have already received partial payment by the worker.”

“The fact that HMRC can then notify workers that they are entitled to a repayment, can potentially lead to a perverse outcome, whereby the worker may not have to pay any employment taxes at all, notwithstanding the fact that if the business had applied the IR35 rules correctly, the worker would have had employment taxes and their NICs deducted through the PAYE system before receiving payment,” she said.

Under the IR35 rules, if HMRC decides that a business has mistakenly determined that a worker was engaged outside IR35 and their income not subject to employment taxes, the business may become liable for the full cost of employment taxes on the worker’s income from their engagement with the business. Currently, the business is unable to set off employment taxes already paid by the worker. HMRC is proposing to introduce a set-off mechanism for income tax and NICs paid by the worker and any corporation tax paid by the worker’s intermediary in relation to the engagement with the business. No set-off will be available for employer NICs, which are payable at a rate of 13.8%. The set-off mechanism is expected to be introduced from April 2024.

Simmons said: “It is unsurprising that set-off will be denied for employer NICs, since these costs would never be borne by the worker and would have always been an absolute cost to the engaging business. However, it is disappointing that the new rules are not expected to have retrospective effect, since the lack of a set-off mechanism is already proving problematic for businesses.”

Tax disputes expert Steve Porter said: “Given that the IR35 changes have been in force for over two years in the private sector, we are now seeing an increasing number of HMRC-led compliance reviews. HMRC accepts that a set-off should be available and acknowledges that the lack of set-off creates an ‘immediate’ issue, so it seems unfair that businesses currently in discussion with HMRC may be denied a set-off.”

“We appreciate that allowing a set-off could be problematic where a worker and their personal service company have already been notified of their entitlement to an overpayment. HMRC needs to review its repayment review policy without delay to enable the set-off mechanism to be introduced retrospectively. In turn, businesses with ongoing IR35 compliance reviews should consider carefully how they proceed with that review to maximise the chances of benefiting from the credit,” he said.   

The IR35 rules require that employment taxes, income tax and NICs by both the worker and the employer, be paid by people who provide services to a business through a personal service company (PSC) or other intermediary if that person would otherwise have been regarded as an employee for tax purposes of the engaging business. Since April 2021, businesses have been required to determine whether engagement with an individual through a PSC falls inside the IR35 rules, and therefore whether the PSC contractor would be considered an employee for tax purposes. This change was introduced in the public sector in 2017.