IR35 set-off rules: how they protect contractors from double taxation

The problem the set-off rules were designed to fix

Before April 2024, there was a genuine double-taxation risk embedded in the IR35 framework:

The scenario: A contractor operates via their limited company, determines they're outside IR35, and pays themselves a combination of salary and dividends. Their limited company pays corporation tax on profits; the contractor pays income tax on dividends.

Later — perhaps following an HMRC compliance check — the engagement is found to have been inside IR35. Under pre-2024 rules, HMRC could pursue the fee-payer (typically the end client or agency) for the full PAYE liability on the contractor's fees, without automatically netting off the taxes the contractor had already paid through their limited company.

This meant the same income could theoretically be taxed twice: once via corporation tax and dividend income tax at the contractor's end, and again via the PAYE liability raised on the fee-payer.

The set-off rules corrected this fundamental flaw.

How the IR35 set-off rules work

From 6 April 2024, HMRC must account for taxes already paid by a contractor's personal service company when calculating any PAYE liability arising from an incorrect inside IR35 determination.

Specifically, HMRC will reduce the PAYE liability of the deemed employer (the fee-payer) by the income tax and employee NICs that the contractor has already paid through their limited company on income from that engagement.

In practical terms:

• If a contractor took salary of £12,570 and dividends of £40,000 from their limited company, paying the relevant income tax and NICs, those payments are factored in.
• The fee-payer's PAYE liability is reduced by the contractor's already-paid tax.
• The contractor can also reclaim overpaid tax from their own returns where applicable.

This doesn't eliminate the liability entirely — employer NICs remain the fee-payer's responsibility and are not offset. But it substantially reduces the financial exposure from a wrong determination.

Who benefits from the set-off rules?

• Contractors operating outside IR35: If HMRC later challenges a determination and wins, the taxes you've already paid through your limited company are factored in. Your fee-payer's liability is lower, which reduces the commercial risk of outside IR35 engagements for both parties.
• Fee-payers (end clients and agencies): Their exposure on a challenged determination is reduced, removing one of the arguments used to justify blanket inside IR35 decisions.
• Historical engagements: The rules apply to determinations made from April 2024 onwards. For legacy disputes pre-dating 2024, the position is more complex — contractors in that situation should take specialist advice.

What the set-off rules don't cover

It's important to be clear about the limitations:

• Employer NICs are not offset. The fee-payer remains fully liable for employer NIC contributions (currently 15%) on the engagement value. This is still a significant exposure on large or long-running contracts.
• The rules don't apply retrospectively before April 2024. Pre-2024 determinations under challenge are still governed by the old rules.
• Set-off doesn't mean HMRC won't investigate. The rules reduce the financial penalty of a wrong determination — they don't prevent compliance checks or make a contractor's outside IR35 position safer. Good contracts and working practices remain essential.
• The process requires HMRC to agree the offset. This isn't automatic in all circumstances — there may be administrative steps required to claim the credit.

How does this change the risk calculation for outside IR35 contracts?

This is where the content earns its reassurance value. For contractors who've been sitting inside IR35 (or on umbrella) partly out of fear of retrospective liability, the set-off rules meaningfully shift the risk picture.

Pre-2024, the argument for risk-averse inside IR35 decisions included: "If HMRC investigates and wins, the liability is the full PAYE bill with no credit for what you've already paid."

Post-2024: if you're genuinely outside IR35 and HMRC challenges and wins, the liability is reduced by the taxes already paid through your limited company. The fee-payer's exposure is lower. The contractor's position is cleaner.

This doesn't mean outside IR35 is risk-free. It means the downside scenario is less catastrophic than many contractors have been told.

The importance of this shift: good contract drafting, accurate working practices that reflect the contract, and ongoing accounting support to ensure your limited company is structured correctly — these remain non-negotiable. But the consequences of being wrong are now materially more manageable.

Does this affect how AutoBooks clients are managed?

Yes. AutoBooks clients operate via limited companies. Where outside IR35 engagements are in place, your accounts, payroll, and corporation tax are managed in a way that creates a clear record of the taxes paid — which is exactly the information needed to calculate any set-off in the event of a challenge.

This is one of the reasons having an accountant who understands contractor taxation is worth more than the monthly fee. When HMRC comes knocking, having a meticulously kept set of records showing exactly what was paid and when — through salary, dividends, corporation tax, and personal tax returns — is your first line of defense and the basis of any set-off claim.

For AutoBooks Gold and Platinum clients, we also provide direct IR35 advisory support to help you understand the status of individual engagements before you enter into them.