IR35 applies to some of your company’s income and so PAYE tax and NI has to be accounted for on a deemed payment of salary. The trouble is that you’ve also drawn the income as dividends. How can you avoid being taxed twice?

IR35

Where your business consists of providing your personal services to clients through a company, special tax rules, known as IR35, can apply. These say that if the terms and conditions of your work would count as an employment if the contract with your client was with you direct instead of through your company, you must pay PAYE tax and NI on the income as if it were salary. The trouble with these tax rules is that they sometimes conflict with company law.

Dividends as well

If your company makes a profit, company law says it can pay it to the shareholders as dividends. Naturally, HMRC expects you to pay tax on these too. This means tax can be payable under two different rules on the same income; once as employment income and secondly as dividends.

Example. Hal’s company, Acom Ltd, provides his services as an IT consultant to his only client. The arrangement is caught by IR35. In Acom’s financial year ended 31 March 2020 the IR35 income was £100,000. In 2019/20 Hal draws £8,000 from Acom as salary and £60,000 as dividends. He also takes another £10,000 of the income as dividends in 2020/21. After the deductions allowed by IR35, Acom must apply PAYE tax and NI to £95,000 as if it had paid Hal that much in salary. This forms part of Hal’s taxable income for 2019/20, but so does the £60,000 dividends, which was paid out of the same income.

Trap. If Hal did nothing he would face a tax bill of up to £19,500 (£60,000 x 32.5%) on the dividends having already paid, say, £20,000 tax through PAYE.

Tip. Hal can avoid double taxation by claiming a special deduction, known as s.58 relief , for the income potentially liable to double taxation).

S.58 relief

The special deduction reduces the amount of dividends on which Hal pays tax. In our example all of the £60,000 dividends are subjected to IR35 tax therefore s.58 relief for 2019/20 would be £60,000. Therefore, the taxable dividends would be reduced to zero. Plus, Hal could make another s.58 claim for 2020/21 of £10,000 in respect of the dividends paid out of the IR35 income in that year. However, if, say, IR35 PAYE tax applied to just £30,000 of Acom’s income, the s.58 relief Hal can claim would be capped to that amount.

The company’s position

IR35 rules also conflict with other legislation; this time the corporation tax (CT) rules. A company can deduct the salaries it pays from its taxable profits. In our example Acom only paid £8,000 salary to Hal in its financial year to 31 March 2020, the other payments to him were dividends, which aren’t deductible for CT. So by applying the normal rules Acom could only obtain CT relief on £8,000, even though £95,000 had in effect been treated as salary.

Tip. Another special rule allows Acom to claim a CT deduction for the £95,000 as if it were an actual salary.