Extracting income where IR35 applies

If the work that you do through your company is caught by the IR35 off-payroll rules, PAYE tax and NI must be accounted for even where you extract the income as a dividend. This can result in a double tax charge. How can you prevent this?  Partner Joanne Gibson looks at this below.

PAYE tax and NI
As you are probably aware, the IR35 and off-payroll rules can apply to income derived from services provided by an individual through an intermediary, typically a company, that’s owned or controlled by the individual. Where these rules apply, either the business receiving the services or the intermediary must treat the income as if it were derived from employment and deduct PAYE tax and NI accordingly. Although the income is treated as if it were earnings, it also counts as taxable income for the intermediary.

However, the double accounting can result in tax being payable twice on the same income.

EXAMPLE
Robert’s company, Bruce Ltd, provides his services as a consultant to its only client. The IR35 /off-payroll rules apply and so PAYE tax and NI is accounted for on the income. In the financial year ended 31 March 2024, the income was £95,000. In 2023/24 Robert draws £9,000 from Bruce Ltd. as salary and £50,000 as dividends. He’s taxed on the salary, but any PAYE tax and NI payable on it has already been accounted for under the IR35 /off-payroll rules. However, Robert is liable to a separate income tax charge on the dividend income even though PAYE tax has been deducted from it.

If Robert did nothing, the double tax charge would stick. However, he can easily avoid it by claiming a special deduction through his self-assessment tax return or by making a standalone claim.

Effect on income
The special deduction reduces the amount of dividends on which Robert pays tax. In our example above all of Bruce Ltd’s £95,000 of income was subjected to PAYE tax and so Robert can claim the special deduction on the full £50,000 of it he took from the company as dividends. His taxable dividend income for 2023/24 is therefore zero. If Robert takes the remainder of the £95,000 as dividends, the amount he can take will actually be less because Bruce Ltd will use some of it to meet its costs, he could make another claim for relief for up to £45,000 (or less depending on Bruce Ltd’s costs).

However, the claim to prevent double taxation of dividend income only cures part of the tax problem that can result where PAYE tax and NI are deducted from income under the IR35 /off-payroll rules. The company’s corporation tax (CT) position also needs to be considered.

The company’s position
Companies can deduct any salaries they pay when working out the profits on which they pay corporation tax (CT). In our example Bruce Ltd. only paid £9,000 salary to Robert in its financial year to 31 March 2024. The other payments to him were dividends, which aren’t deductible for CT. This means under the normal CT rules, Bruce Ltd could only claim a deduction for £9,000, even though £95,000 had in effect been taxed as salary.

To obtain CT relief for the full £95,000, Bruce Ltd must submit another type of special claim (with its self-assessment return) to HMRC.

IN SUMMARY
A double income tax charge applies where income from which PAYE tax and NI under the IR35/off-payroll rules has been deducted is then paid as dividends. A special claim is required to remove the dividend tax. A different claim should also made by the intermediary, e.g. the company, to obtain corporation tax relief.

For any further questions about similar related matters, please contact our tax team directly.