Originally posted on: 12 August 2024
Updated on: 23 March 2025
We often receive questions from our contractor clients about the current state of IR35 and what (if any) changes are coming down the pipeline. Understandably, there’s a lot of uncertainty around what these changes mean for day-to-day operations, particularly the potential impact of the new Labour government. We’ve also seen a surge in queries from clients working remotely (and knowing how IR35 applies when working with foreign clients is useful), highlighting the increasingly global nature of contracting. And of course, the ongoing discussion about the inherent unfairness of an inside-IR35 contractor paying full taxes without receiving employment rights remains a hot topic.
This week’s blog aims to address these concerns and provide clarity on the key aspects of IR35. We’ll break down the fundamentals of IR35, delve into the specifics of the double taxation changes coming into effect in April, and explore the potential implications of the Labour government’s stance on IR35. We’ll also shed light on how IR35 operates when working with clients based outside the UK and reiterate the disadvantages of operating within IR35 while highlighting potential solutions. Finally, we’ll provide an overview of useful tools designed to simplify IR35 compliance and minimise your administrative burden.
Whether you’re a seasoned contractor or just starting out, understanding the ins and outs of IR35 is important for protecting your income and ensuring compliance. So, grab a coffee, settle in, and let’s navigate the world of IR35 together.
Key Takeaways
- Starting April 6, 2024, new IR35 rules were introduced to limit HMRC’s ability to issue large tax bills for past determinations, allowing businesses to offset previously paid taxes against PAYE liabilities.
- The recent Labour government, while lacking specific proposals on IR35, is expected to impact employment status and worker rights, necessitating vigilance from contractors and clients regarding potential reforms.
- Contractors working with foreign clients may retain responsibility for their IR35 status determination, presenting opportunities and complexities, especially when engaging in cross-border arrangements.
Overview of IR35 and Off-Payroll Working Rules
What use is a blog article about IR35, without an introduction to the subject that has been around since 2000. So here it is 🙂 IR35, initially introduced in April 2000 under the Finance Act, was designed to combat tax evasion by ensuring that contractors who essentially work as employees do not avoid paying the appropriate taxes. The purpose of IR35 is to ensure that limited company contractors are taxed similarly to permanent employees, thereby preventing tax avoidance. This legislation requires contractors falling under its scope to pay Income Tax and National Insurance Contributions (NICs), similar to regular employees.
Over the years, IR35 has undergone significant changes, particularly with the introduction of the off-payroll working rules. These rules, which came into effect in April 2017 for the public sector and April 2021 for the private sector, shifted the responsibility for determining a contractor’s status from the contractor to the client. This was intended to simplify compliance and ensure that the correct taxes were paid, but it also introduced new challenges and complexities for businesses and contractors alike.
One important aspect of IR35 is the distinction between being “inside” or “outside” the legislation. This determination hinges on the nature of the working relationship between the contractor and their client. Contractors deemed to be inside IR35 are treated as employees for tax purposes, meaning they have to pay income tax and NICs through PAYE deductions, whereas those outside IR35 can benefit from the tax efficiencies of operating through a Personal Service Company (PSC).
Both contractors and clients need to understand these off-payroll rules. Contractors must navigate tax legislation complexities to comply and maximise take-home pay. Clients face the challenge of managing payroll risks and making correct determinations to avoid hefty tax bills and HMRC penalties.
The IR35 and off-payroll working landscape is constantly changing, requiring vigilance and proactive management. Previously we have written about the options available to contractors where the client won’t hire outside IR35.
In our previous blog “Contractors vs. Employees: Who Really Pays More in Taxes Now?” we looked at how the taxation landscape has changed so significantly in the last 20 years, to the point where we feel IR35 is now out-dated and largely ineffective in achieving its original goals.
Key Changes Effective April 2024
Starting on April 6, 2024, new IR35 rules came into effect, bringing significant changes aimed at reducing financial risks for businesses. One of the most notable updates is the limitation on HMRC’s ability to issue disproportionately large tax bills for incorrect IR35 determinations made in the past. This change is designed to alleviate the financial burden on organisations that have struggled with the complexities of IR35 compliance.
A key benefit of the new rules is the ability for businesses to offset taxes already paid by contractors against their PAYE liabilities. This means that companies engaging limited company contractors can do so without the fear of excessive financial risk. This update promotes a more balanced approach to engaging contractors and encourages businesses to continue utilising the flexible workforce that is vital to many industries.
However, these new relief measures won’t apply to contractors’ past tax liabilities before April 2024. Although the new rules offer significant future benefits, they do not provide retroactive relief.
As businesses and contractors navigate these changes, understanding the new rules will be crucial for effective compliance and financial planning.
IR35 Double Taxation Worked Example
It seems hard to believe, but for the public sector this has been an issue since 2017, and for the private sector since 2021. It is such a bad oversight that I can’t help but give you a brief worked example. Here you will see that under the old rules, the workers income was taxed at an overall rate of 74%!
Let’s say Helen worked for a year as a contract engineer on for Big Wind Ltd, a large wind farm construction project. She worked 45 weeks and was paid £400 per day. She worked though her limited company and had various business expenses that you would expect from a contract engineer. Her business had a turnover of £90,000 and a net profit before tax of £77,900. Her business then paid £16,893 in corporation tax, and she drew down £55,000 in dividends. Based on the total income she received from her business, she faces a personal tax bill of £7,877. Overall, the total taxes paid to the HMRC is 16,893 + 7,877 = £24,770.
A couple of months later as part of an IR35 compliance visit by the HMRC, it was decided that the work provided by Helen should have been deemed inside IR35 instead. As per the 2021 private sector rules, that tax liability now falls on the end client. So now Big Wind Ltd must treat £90,000 as if it were paid to an employee as a gross salary. First up, we need to add employers NIC and apprenticeship levy costs. This totals £12,870. Then Big Wind Ltd also becomes responsible for deducting PAYE and employees NIC which totals £28,557. So, in addition to the £90,000 paid to Helen, Big Wind Ltd must now pay a further £41,427 to the HMRC.
Prior to April 2024, there was no recognition of taxes already paid by Helen on this same income, so we would have the scenario where the HMRC would collect £24,770 in taxes from Helen and her ltd company, and a further £41,427 in taxes from Big Wind Limited. In total that is £66,197 in taxes paid on income of £90,000. This combines to give an effective tax rate of 74% on £90,000 of annual income, and if that seems unfair, it is because it is!
From April 2024, the HMRC will use “assumptions and best judgement to estimate the amount of tax paid by a worker” to give a fairer tax calculation. Best case scenario in the situation above is the tax liability facing Big Wind Ltd drops from £41,427 to £16,657.
Addressing Double Taxation from April 2024
As mentioned above, double taxation under IR35 has been a major concern, where contractors could end up paying income tax on dividends while their PSC also pays corporation tax. Starting April 6, 2024, the new rules will address this issue, allowing businesses to offset tax already paid by contractors against their PAYE liabilities.
The new offset mechanism will include various forms of tax, such as corporation tax and income tax, while excluding employer NICs and the Apprenticeship Levy. This change aims to decrease the financial penalties associated with double taxation and provide a more balanced approach to tax compliance and tax liability. This means that businesses will now be able to share tax information with HMRC regarding the taxes paid by contractors or their PSCs to facilitate potential tax relief.
While this new approach to offsetting taxes provides significant relief, businesses must understand what taxes are included and excluded under the new rules. Staying informed and proactively managing these changes will be essential for effective compliance and financial planning.
Labour Government impacts
The Labour Party’s comprehensive victory on July 4th marked the end of 14 years of Conservative leadership, bringing new hopes and expectations for contractors and the self-employed. Under the previous administration, many in the flexible workforce felt increasingly marginalised, with policies that seemed to target their way of working. With Labour in power, there is anticipation for a breath of fresh air and supportive changes, but what can contractors and employers realistically expect?
Labour’s manifesto lacked specifics on IR35, but it pledged to address employment status and worker rights, a long-standing contentious issue. Employment status in the UK is complex, involving distinct streams for employment rights and tax purposes. Labour’s proposal to simplify this by removing the ‘worker’ status and ensuring full employment rights for everyone except the “genuinely self-employed” could have significant implications.
Despite focusing on employment status, Labour has remained silent on IR35 specifically. Given IR35’s prominence and impact on businesses and contractors, it will likely become a governmental focus. Engaging with MPs and keeping IR35 in the public eye will be essential for driving potential reforms. The upcoming Autumn Statement will be a key moment to watch for any concrete plans or changes that Labour may propose regarding IR35 and the off-payroll rules.
Potential legislative changes under the new government bring both hope and uncertainty. We think contractors and employers should keep their eyes and ears open, engage with policymakers, and stay informed about developments. The evolving political landscape could reshape IR35’s future, requiring all stakeholders to prepare for potential shifts.
Working for Foreign Clients
With the rise of global flexibility, more contractors are exploring opportunities to work for foreign clients. The appeal of sourcing talent across borders has led to an increase in platforms like Fiverr which facilitate international engagements. For UK-based contractors, this trend opens up many possibilities but also raises questions about IR35’s application to cross-border relationships.
If a contractor uses a UK-based contractor’s limited company and pays tax in the UK, IR35 still applies. The key question is which version of the IR35 rules will apply. Contractors working with foreign clients are exempt from the reformed IR35 rules making clients responsible for determining status. Instead, the contractor retains this responsibility, which can be a relief given the risk-averse behavior of many organisations.
However, this exemption includes important caveats. A client is considered foreign only if they have no UK connection, such as an office or factory. If a UK-based recruitment firm is involved, the situation remains unchanged, and if you work for a foreign client with no UK footprint, the “old” IR35 rules still apply where the contractor retains responsibility of the IR35 assessment.
As the global workforce evolves, it’s useful for contractors to understand how IR35 applies to engagements with foreign clients. This knowledge helps maximise opportunities while ensuring tax compliance. International work offers many benefits but requires careful consideration of associated risks and responsibilities.
Full Tax Without the Employment Rights
One of the most contentious aspects of IR35 is treating contractors as employees for tax purposes while denying them associated employment rights. Inside IR35, contractors pay income tax and NICs like employees but do not receive benefits such as holiday pay, sick pay, or maternity/paternity leave, creating a fundamentally unfair scenario often called “zero-rights employment”.
The financial impact on contractors classified as inside IR35 is significant, often reducing their take-home pay by up to 30% compared to those outside IR35. This financial burden and lack of employment rights create a double disadvantage. Despite calls for reform, the government has consistently failed to align tax status with employment rights.
This misalignment of rights and tax status not only deters skilled workers from engaging with UK businesses but also creates legal contradictions where employment law and tax law clash. Contractors are left in a precarious position with limited legal recourse to claim employment rights. Contractors and industry experts strongly demand the government address this issue and ensure that those paying taxes as employees also receive associated benefits and protections.
Businesses should conduct thorough IR35 assessments to ensure accurate classification of contractors and avoid forcing genuine freelancers into “zero-rights employment” inside IR35. The current IR35 legislation significantly impacts the gig economy, potentially stifling its growth and flexibility by discouraging self-employment.
Tools and Resources for Simplifying Compliance
Navigating IR35 compliance can be challenging, but various tools and resources are available to simplify the process. IR35 and payroll specialists assess risks, develop management plans for contractor relationships, and ensure compliance. Employers/end-clients must comply with existing off-payroll working rules and regularly revisit their compliance processes.
Contract assessment tools are essential for verifying IR35 status through contract reviews and evaluations of working practices. These tools can help businesses ensure that their contracts comply with IR35 regulations and avoid potential pitfalls. Additionally, various free guides and resources are available to assist businesses in understanding IR35 legislation and preparing for potential HMRC inquiries.
We strongly believe that with the right planning, most end clients can successfully engage limited company contractors while minimising their risks to IR35. There are numerous providers that can help employers navigate this area, and once they successfully do so they open up their business to a whole new pool of qualified and experienced limited company contractors who can help make a significant impact to their business operations. Loosening up this part of the flexible workforce will bring significant advantages to those businesses who move on this faster than their competitors.
Summary
The announced changes to IR35 in April 2024 bring a significant improvement to how taxes are collected from end-clients impacted by IR35. From limiting HMRC’s ability to issue large tax bills for past errors to allowing businesses to offset taxes already paid by contractors, these changes aim to reduce financial risks and promote fairer tax practices. The Labour government’s focus on employment status and worker rights could also lead to further reforms, making it essential for us all to stay informed and engaged.
As the landscape of IR35 continues to evolve, utilising available tools and resources for compliance will be crucial for managing tax obligations effectively. By staying proactive and informed, contractors and employers can navigate these changes and ensure that they are well-prepared for the future of limited company contracting.
Frequently Asked Questions
Is IR35 going to be reversed?
A complete reversal of IR35 is unlikely. The new Labour government may consider adjustments to address criticisms regarding complexity and unfairness. Rather than hoping for a complete reversal, we think you should focus on understanding the current rules, ensuring compliance, and advocating for changes that promote fairness and support the flexible workforce.
What are the key changes to IR35 effective April 2024?
The key changes to IR35 effective April 2024 involve restrictions on HMRC’s capacity to issue large tax bills for incorrect determinations and the ability for businesses to offset taxes already paid by contractors against their PAYE liabilities. And it’s about time!
How does Labour’s victory impact IR35 and contractors?
Labour’s victory may lead to simplified employment status and improved worker rights, though their specific stance on IR35 remains unclear. Let’s wait and see if the Autumn Statement clarifies their plans.
How does IR35 apply to contractors working for foreign clients?
IR35 applies to contractors using a UK-based limited company, regardless of the client’s location. However, if the client is foreign with no UK connection, the contractor is responsible for determining their IR35 status (and not the end client). The risk of an incorrect IR35 determination falls to the contractor, which is especially useful for risk-averse clients.
What is double taxation under IR35, and how is it being addressed?
Double taxation under IR35 occurs when contractors are taxed on dividends, when their company pays corporation tax, and where an “inside-IR35” determination is later made making the end-client pay full taxes on the income paid to the contractor, without any relief for the taxes the contractor paid already. From our worked example in this blog, this can create an overall tax rate of 74%! This issue is being addressed by allowing end clients to offset taxes already paid by the contractor.