IR35 Contractor Guide: New Double Taxation Fix Explained

If you’re a contractor or work with contractors, April 2024 marked a turning point in IR35 legislation.

After years of complaints about unfair tax bills and “double taxation” under the off-payroll working rules, HMRC finally introduced what experts are calling “a game-changing moment” – the IR35 offset mechanism.

The changes address a fundamental flaw that has plagued the legislation since its introduction to the public sector in 2017 and private sector in 2021.

But what exactly is the IR35 double taxation fix, how does it work, and what does it mean for contractors and businesses moving forward?

Understanding IR35: The Essential Context

IR35, officially known as the off-payroll working rules, determines whether contractors working through intermediaries like personal service companies should pay tax like employees or genuinely self-employed individuals.

The legislation targets “disguised employment” – situations where someone works like an employee but avoids paying the same tax and National Insurance by routing income through a company. If you’re caught “inside IR35”, you pay employment taxes on your contractor income. 

If you’re “outside IR35”, you can take advantage of the more tax-efficient dividend and salary combination that limited companies offer.

Who Determines Your Status?

This depends on your client’s size. Medium and large companies must assess your IR35 status and handle tax deductions if you’re inside the rules.

Small companies are exempt from this responsibility – meaning you determine your own status and handle the tax consequences.

The Stakes

Get it wrong, and the financial consequences can be severe. HMRC can issue backdated tax bills, charge interest, and impose penalties.

For businesses, this previously meant facing tax bills that were sometimes four times the actual amount owed – until the double taxation fix arrived.

What Was the Double Taxation Problem?

The double taxation issue arose when HMRC disagreed with a company’s IR35 status determination. 

Picture this scenario: you’re working through your personal service company, classified as “outside IR35” by your client. You dutifully pay corporation tax on your company profits and dividend tax on any distributions you take.

Then HMRC comes knocking. After an investigation, they decide you should have been “inside IR35” all along. Your client gets hit with a massive employment tax bill covering all the PAYE and National Insurance that should have been deducted from your payments.

Here’s the kicker – HMRC didn’t offset the taxes you’d already paid through your company. The same income was being taxed twice, sometimes creating tax bills that were four times what was actually owed. One expert described it as a “quadruple-tax threat” due to the calculations.

This unfair system created several problems:

• Disproportionate penalties that bore no relation to the actual tax shortfall
• Risk-averse clients who implemented blanket “inside IR35” determinations
• Contractor bans by businesses terrified of excessive tax bills
• Market distortion where genuine self-employed contractors couldn’t find work
• Administrative burden for businesses trying to navigate complex compliance

The result was a contractor market where fear drove decision-making rather than the actual working relationship between contractor and client.

HMRC’s April 2024 Solution: How the Offset Works

From 6 April 2024, HMRC introduced an automatic offset mechanism that finally addresses these issues.

When HMRC issues a tax bill for IR35 non-compliance, they now account for taxes the contractor has already paid.

The offset mechanism includes:

• Corporation tax paid by your personal service company
• Income tax and employee NICs already deducted from salary payments
• Dividend tax you’ve paid on company distributions
• Other relevant taxes connected to the engagement

However, it doesn’t include employer’s National Insurance or the Apprenticeship Levy – businesses remain liable for these costs.

The beauty of this system is its retrospective application. It covers all IR35 cases going back to April 2017 for public sector engagements and April 2021 for private sector ones. If you’re currently dealing with an HMRC investigation that started before April 2024, you can potentially benefit from these offset rules.

How HMRC’s Fix Benefits Businesses

The financial implications are dramatic. Under the old system, businesses could face tax bills worth four times the actual underpaid amount. Now, industry experts suggest the extra tax liability typically works out to around 10-15% on top of contractor fees.

Let’s break this down with a practical example. Say a company engages 100 contractors and gets IR35 status wrong for 10% of them (which would be unusually high).

Under the new system, the extra tax due would be roughly 1-1.5% of their total contracting spend, rather than the potentially crippling amounts possible under the old rules.

This proportionate response removes the existential threat that many businesses felt when engaging contractors.

The penalty now fits the “crime” – you pay the employment taxes that should have been paid, plus some interest, rather than facing multiples of the actual liability.

What This Means for Contractors

While the offset mechanism primarily protects businesses, it creates significant opportunities for contractors. Here’s what you need to understand about how these changes affect your working life.

More Outside IR35 Opportunities

With the fear of disproportionate penalties removed, expect to see more clients willing to properly assess IR35 status rather than defaulting to “inside” determinations. This creates genuine opportunities for contractors who operate as proper businesses.

Loss of Refund Rights

There’s a trade-off though. Under the new system, contractors can no longer claim refunds for taxes they’ve overpaid when their client gets an IR35 determination wrong. The offset mechanism works in the business’s favour, essentially. 

Historical Claims Still Possible

If you paid IR35-related taxes in previous years and believe you were overtaxed, you might still claim overpayment relief. However, strict time limits apply – typically four years from the end of the relevant tax year.

Small Company Threshold Changes: The 2025 Game Changer

Another major change is coming that will affect thousands of contractors, though its impact won’t be felt until 2026 or 2027. Changes to the small company thresholds mean that more businesses will fall entirely outside the off-payroll working rules.

The New Thresholds

For financial years beginning on or after 6 April 2025, a company qualifies as “small” if it meets at least two of these criteria:

• Annual turnover of £15 million or less (up from £10.2 million)
• Balance sheet total of £7.5 million or less (up from £5.1 million)
• Monthly average of 50 employees or fewer (unchanged)
• Two consecutive years meeting the criteria before exemption applies

Due to how company size is assessed using previous financial years, the earliest these changes will practically affect IR35 compliance is the 2027-28 tax year for most businesses.

Who’s Affected

Government estimates suggest around 14,000 companies will transition from “medium” to “small” status, meaning they’ll no longer need to assess contractor IR35 status.

Instead, this responsibility reverts to the contractors themselves.

Understanding the CEST Tool

The CEST tool (Check Employment Status for Tax) is HMRC’s free online service that helps determine whether IR35 applies to a specific contract. 

HMRC stands by all CEST determinations, provided the information entered is accurate and remains accurate. This makes it particularly valuable for contractors who want certainty about their status.

The tool can produce three possible outcomes: employed for tax purposes (inside IR35), self-employed for tax purposes (outside IR35), or “unable to determine” in more complex cases.

The tool considers key employment status indicators, including personal service, control, and financial risk. It asks detailed questions about substitution rights, whether you can send someone else to do the work, who controls how and when the work is done, and whether you bear financial risk from the engagement.

One significant advantage of using CEST is that its output serves as a valid status determination statement. This means contractors working with small companies can use the tool’s results to formally document their IR35 status decision.

When using CEST, be honest about the actual working arrangements rather than what’s written in contracts. 

Getting Professional Help with IR35

IR35 remains complex, and these recent changes add new considerations. Whether you’re dealing with offset mechanisms, preparing for threshold changes, or determining your status using status determination guidelines, professional guidance can save you time, money, and stress.

At Double Point, we specialise in helping contractors and businesses master IR35. Our chartered accountants understand the legislation’s nuances and how to structure your affairs for both compliance and tax efficiency.

Book a free consultation with our specialist team today to review your situation and develop a plan that protects your interests while maximising your contracting success.