Companies and their owners with income subject to the IR35 rules are at risk of being taxed twice on the same income. When can this double tax apply and how can you prevent it?
Off-payroll work subject to IR35
In April 2021 the IR35 rules were extended to private sector work. They can apply to work you personally do for your clients if you own or control 5% or more of your company’s share capital or are a member of a partnership (IR35 cannot apply to sole traders). If the terms and conditions of your work would count as an employment if your contract with your client was with you direct rather than through your company, they must (unless they are a small business) deduct PAYE tax and NI from what they pay you. This can result in double taxation if your business operates as a limited company.
Extracting profit as dividends
As a shareholder, if your company makes a profit it can pay it to you as dividends. These are taxable as income even if IR35 PAYE tax has already been deducted by your customer. Without further action this double tax could stick.
Example. Ali’s company, Acom Ltd, provides his services as a safety consultant. The arrangement is caught by the IR35 off-payroll rules. In Acom’s year ended 31 December 2024 this income was £100,000. In 2024/25 Ali draws £8,500 from Acom as salary and £60,000 as dividends. He takes another £10,000 as dividends in 2025/26. After the deductions allowed by IR35 Acom’s customers deducted PAYE tax (and NI) from £90,000 of the amount paid to Ali. This is less than the £100,000 to which IR35 applied because Ali had some tax-free pay which was reflected in a PAYE code number sent by HMRC to the customer.
Trap. Ali faces a tax bill of up to £20,250 (£60,000 x 33.75%) on the dividends even though PAYE tax has already been deducted from the income.
Tip. To avoid this double taxation Ali must make a special claim for so-called s.58 relief.
Special relief - how it works
S.58 relief reduces the dividends on which Ali is liable to pay tax. In our example Ali can claim s.58 relief for the full £60,000 dividends paid by Acom to him in 2024/25 which prevents any double taxation. Ali could make another s.58 claim for 2025/26 for £10,000, for the dividends paid out of the off-payroll income in that year. Note that s.58 relief is limited to the amount of income from which PAYE tax has been deducted. In our example that’s £90,000.
Another claim
IR35 rules also conflict with the corporation tax (CT) rules. Usually, a company can deduct the salaries it pays from its taxable profits. In our example Acom only paid £8,500 salary to Ali in its financial year to 31 December 2024. It can claim a CT deduction for this but not for the dividends it paid. Applying the normal rules Acom can only obtain CT relief on £8,500, even though £90,000 had in effect been taxed as if it were salary.
Tip. By making a special claim Acom is entitled to claim a CT deduction for the £100,000 as if it had paid it as salary to Ali.
This article has been reproduced by kind permission of Indicator – FL Memo Ltd. For details of their tax-saving products please visit www.indicator-flm.co.uk or call 01233 653500.