As of the 6 April 2024, regulations around IR35 changed to prevent double taxation where hiring firms have misclassified the tax status of contractors under off-payroll working rules. Since the introduction of IR35 in the public sector in 2017 and the private sector in 2021, hiring organisations have complained about the complicated system and the expensive risks involved if they get it wrong.

Many businesses that would benefit from contract labour have been unwilling to risk being hit by additional unexpected tax bills should HMRC disagree with the tax status they have applied to workers. The reduced risk through the offset mechanism introduced in the new financial year could, therefore, also give a boost to the contract market in 2024.

What is double taxation?

A worker deemed by the hirer as being 'inside' IR35 would have their taxes managed and deducted by the hirer before they are paid, and so taxes would not come out of the take-home pay they collect for their work. For workers determined as 'outside' IR35, the worker is responsible for ensuring all relevant taxes are paid out of their fee.

Determining whether a worker counts as 'inside' or 'outside' IR35 is complicated. In most cases, contractors paid by an umbrella company are unlikely to be subject to off-payroll working rules, and would therefore be considered 'inside' IR35, meaning their tax is managed for them by their umbrella company.

Double taxation occurs when the end-user, or the firm hiring the worker, places the contractor 'outside' of IR35, essentially saying that this worker is self-employed and manages their own taxes, and HMRC disagrees.

If, following an investigation, HMRC considers a worker to be 'inside' IR35 when they have been registered by the hirer as 'outside', the hirer must pay all the employment taxes, including full PAYE and Employer National Insurance Contributions, which they previously did not pay. Any taxes already paid by the contractor would not offset the taxes owed by the hiring organisation, hence double taxation. Depending on the circumstances, the underpaid taxes can amount to a significant sum.

What changes is the government making?

The government's IR35 legislative solution to avoid double taxation, effective from 6 April 2024, brings greater clarity and a fairer approach to tax liabilities for hirers and should reduce the number of cases brought against HMRC where there is disagreement over the figures.

Businesses will still need to comply with IR35 rules and may still find themselves facing an inquiry from HMRC and required to pay additional employment taxes where a contractor has been incorrectly determined as outside of IR35. However, they may now be able to significantly reduce this bill for underpayment through the new offset mechanism.

For contractors, where incorrect tax payments have been made on account of IR35 misclassification, there is no automatic offset for taxes already paid. However, it is possible to lodge an overpayment relief claim with HMRC, usually within four years, to reclaim overpaid taxes.

The IR35 rules remain complicated and unpopular, with risks of non-compliance, and alternative solutions may be sought by the government in due course. Contract workers and anyone who engages them will need to keep an eye on tax regulation for any further changes that will impact them and should seek professional advice if they are unsure how to operate compliantly within the current legislation.