Navigating IR35: Preventing Double Taxation on Dividend Income

January 25, 2024

The application of IR35 (off-payroll) rules to income derived through a company can lead to a double tax charge, particularly when extracting income as dividends. Understanding the implications and taking proactive measures is crucial to avoid unnecessary financial burdens.

PAYE Tax and NI Under IR35

When the IR35 and off-payroll rules apply, income from services provided through an intermediary, such as a company, is treated as if it were derived from employment. This triggers the deduction of PAYE tax and National Insurance (NI). While the income is considered as earnings, it also becomes taxable income for the intermediary, leading to potential double taxation.

The Double Tax Trap

The double accounting scenario arises when PAYE tax and NI are deducted under IR35 rules, and the same income is later paid out as dividends. This can result in paying tax twice on the same earnings, creating a financial challenge for individuals and their companies.

Mitigating the Issue

Example Scenario:Arnie operates as a consultant through his company, Acom Ltd. The IR35 rules apply, prompting the deduction of PAYE tax and NI on the income. In a financial year where Acom's income was £95,000, Arnie took £9,000 as salary and £50,000 as dividends. The challenge lies in the separate income tax charge on the dividend income, despite the deduction of PAYE tax.

Proactive Measures:To prevent the double tax charge, individuals like Arnie can claim a special deduction through their self-assessment tax return or make a standalone claim. This special deduction reduces the amount of dividends subject to tax, offering relief for the income previously accounted for under IR35 rules.

Considerations for the Company

While the individual addresses the personal tax implications, the company's position must also be considered. Companies can deduct salaries for corporation tax (CT) purposes, but dividends are not deductible. In Arnie's case, Acom's £95,000 income had effectively been taxed as salary, but only the £9,000 salary is deductible for CT under normal rules.

CT Relief Measures:To obtain full CT relief for the £95,000 income, Acom must submit a special claim with its self-assessment return to HMRC. This ensures that the company's CT position aligns with the tax treatment of salaries and dividends.

Navigating the Double Tax Challenge

Addressing the double income tax charge requires a two-pronged approach: the individual must claim relief for dividend taxation, and the company should seek CT relief through a special claim. Proactive measures, clear understanding of tax implications, and timely claims are essential to navigate the complexities of IR35 rules and prevent unnecessary financial burdens.

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