What is the IR35 offset for contractors?

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The long-awaited ‘offset’ legislation, or ‘set-offs’ legislation from HMRC is now in force.

Its purpose to create a more level playing field and prevent the over collection of tax, commonly referred to as ‘double taxation,’ writes Charlie Hemsworth, a director of status advisory Bauer & Cottrell.  

What is the IR35 offset and why was it introduced in 2024-25?

Previously, if HMRC found that a contractor’s end-client had incorrectly assessed the contractor as ‘outside IR35,’ there was no provision to consider taxes the contractor had already paid on that income against the client’s (or deemed employer’s) tax liability.

Well, the offset is a fix to that problem.

In fact, effective from April 6th 2024, the offset now allows for such tax payments to be offset against the tax bill of the client or deemed employer, under certain conditions.

When does the IR35 set-off legislation apply?

The offset can be applied to retrospective payments made from the start of the implementation of the off-payroll working rules into the public and private sectors – April 6th 2017 and April 6th 2021 respectively.

But HMRC says the set-off does not apply to any IR35 and OPW case or cases that were resolved and closed prior to April 6th 2024.

My commiserations to any businesses in that unfortunate category!

How does the IR35 set-off work and what are the conditions for offsetting?

Once a liability has been determined, for HMRC to consider an offset, it must verify that the contractor has actually paid or been assessed for taxes on the income received from the engagement.

The client must provide the information to enable HMRC to establish this, including the contractor’s name, NI number, and their limited company name. So contractors take note!

Under the IR35 offset, what is HMRC’s ‘best estimate?’

HMRC will then use this information to check tax return records, to establish what, if any, taxes the contractor has already paid or been assessed on for their income from the engagement.

The amount of the offset is calculated using HMRC’s “best estimate” based on the information available.

If HMRC cannot identify the contractor or their tax records, there will be no eligibility for an offset.

Where sufficient evidence of tax paid can be identified by HMRC, both the client/deemed employer and the contractor are then issued with a “direction notice,” which includes the amount eligible for offset and the tax years to which it relates.

The contractor must agree with the information set out in the direction notice but there are avenues to appeal if they don’t. 

What taxes does the IR35 set-off cover and not cover?

The offset covers Income Tax (on both salary and dividends), Corporation Tax and Class 1 (employee) 2 and 4 NICs accounted for by the contractor on income from the engagement. 

Secondary Class 1 (employer) NICs or VAT paid by the contractor cannot be offset, neither can any tax paid on income that does not relate to the engagement under determination.

What next for off-payroll working contractors and clients?

Contractors:

As you can see, if any of your previous clients are ever in a situation where they need to trigger the set-off legislation in relation to an incorrect IR35 determination on your role, this will probably result in HMRC delving through your tax records. 

It’s crucial to maintain thorough and accurate records and ensure all taxes are paid and well-documented, easily verifiable and reflect your business activities. This will put you in good stead should the information ever be needed for set-off purposes.  

You should also be aware that once the set-off is applied, you cannot claim these taxes back in any other form, thereby closing the door on potential future refunds for these payments.

Clients:

It’s essential to maintain detailed records of the contractors you are engaging, including with respect to their IR35 status.

Adequate record keeping could save you a lot of work should you ever need to make use of the set-off facility, especially if you engage contractors in high numbers. Failure to provide accurate and timely information could lead to complications in applying the set-off, leaving your organisation unable to benefit from it.

While I hope you will never be in the position to need it, the set-off as a fix does provide some comfort to those facing an IR35 audit from HMRC, now or in the future. The obligation to take “reasonable care” over your determinations remains, and penalties for non-compliance will still apply to the entire tax liability (including any amounts offset) where it is found such care has not been taken. Getting things right with contractor IR35 status from the outset should help you avoid even having to think about the set-off mechanism.

Final thoughts on the finally in force set-off legislation for IR35/Off-payroll working

It’s taken seven years for HMRC to fix this issue!  So in this current tax year of 2024-25 and onwards, we have a late, albeit welcome step forward for both clients and contractors, even though at the same time it represents another twist in the already complex rules, highlighting that prevention is always better than cure. To aid in that prevention, strongly consider consulting a trusted, experienced and qualified employment status or IR35 specialist.

Written by

Charlie Hemsworth

Tax Consultant at Bauer and Cottrell

Charlie Hemsworth has been a tax consultant at leading IR35 and employment status specialists Bauer and Cottrell since 2015, and has over 20 years of experience in the contractor industry. She currently advises contractors, engagers and agencies in all things IR35 / Off-Payroll, ranging from IR35 reviews and assessments, to representing clients in HMRC enquiries.

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