With the imminent arrival of off-payrolling for the private sector from April 2020, Peter Bickley reflects on whether the prospective new rules will change how businesses engage contractors. He covers IR35 and off-payroll working rules, tax compliance for the personal service company and a working example, as well as further guidance for Tax Faculty members.

Businesses and the public sector engage contractors to provide various services. Contractors may opt to do this through a personal service company (PSC) for many reasons, including limited liability or status. However, the biggest perceived reason is the potential tax saving.

As a result, both the original ‘IR35’ rules (contained in Ch 8, Pt 2, Income Tax (Earnings and Pensions) Act 2003 (ITEPA 2003)) and the new off-payrolling rules (contained in Ch 10, Pt 2, ITEPA 2003) are intended to ensure that fees are treated as employment income for tax and NIC where they concern:

• personal services provided to a client by an individual, otherwise known as a contractor, through their intermediary (commonly a PSC); and
• an individual who would have been an employee if they had contracted directly with the client.

This article focuses on the new off-payroll rules from the viewpoint of the contractor and their PSC. It is based on my current understanding of the law and how it is supposed to operate in practice. There remain many points that need clarifying.

The IR35 and off-payroll working rules

Since 6 April 2000, contractors who use a PSC to provide services to clients have been responsible for deciding whether the so-called IR35 rules apply to make them a deemed employee. If they do, the PSC must draw up an IR35 computation which includes accounting to HMRC for PAYE on (broadly) 95% of fees received.

However, compliance with these rules has been poor and difficult to enforce. Government estimates suggest compliance by PSCs with the rules is as low as 10%.

To plug this gap, for payments since 6 April 2017 where the client is a public authority, or, prospectively from April 2020, for a private sector client that is not ‘small’, the client rather than the contractor is responsible for deciding whether the off-payroll working rules apply. Where they do, the contractor is a deemed employee.

Whether the business is ‘small’ and is outside the prospective rules for the private sector relies on a definition similar to that in Companies Act 2006 for financial reporting.

If the off-payrolling rules apply, the client must issue a status determination statement (SDS) to the party with whom they have contracted and the contractor. They must also set up a disagreements process to deal with objections on employment status from contractors.

If a contractor is a deemed employee, income tax, class 1 NIC and apprenticeship levy (AL) must be accounted for via payroll on the fees paid to the PSC by the party with whom the PSC has contracted (known as the fee-payer), rather than the PSC. The contractor will need to provide the party responsible for paying their PSC with the information needed to do this.

In practice, who bears the cost of secondary (employer’s) NIC and AL accounted for by the fee-payer, (ie, whether it is the PSC, the end client, the fee-payer or someone else in a labour chain) will depend on the terms of the contract under which the contractor performs the work for the end client. It is expected that this should be the client. Class 1 secondary NIC and AL accounted for by the fee-payer must not be passed on to the PSC, unless the contract so allows.

The fee-payer is required from the outset to withhold tax via payroll at basic rate, 20%. If HMRC does not issue a more accurate code before the end of the contract or the tax year, this may result in additional tax being payable by or refundable to the contractor when HMRC reconciles the contractor’s earnings after the end of the tax year. If the contractor is over state pension age, class 1 primary NIC (employee’s NIC) will not be deductible.

If the fee invoice for the work includes VAT, or expenses which would be allowable if the contractor were a direct employee of the client, these will be payable without the deduction of PAYE.

In the accounts of the PSC, the gross fee income should be treated as turnover, with PAYE deducted included in staff costs or similar. VAT needs to be accounted for as normal, and expenses reimbursed offset against expenses incurred.

If any of the parties in the labour chain are not resident or domiciled in the UK or the work itself takes place outside the UK, the rules are modified.

Tax compliance for the PSC and the contractor

Under the 2017 public sector and the prospective private sector off-payrolling rules, for income tax purposes, the fee income subjected to PAYE by the fee-payer is treated as if it were the income of the contractor. The PAYE income tax is payable on account of the contractor’s own income tax. The class 1 NIC accounted for qualifies the contractor to receive certain social security benefits, such as state pension, but we are trying to clarify with HMRC whether a deemed employee can, as the law stands, qualify for statutory payments.

The contractor should include the deemed employment income in their self assessment tax return on an employment page, showing the fee-payer as the employer.

In order that the fee income does not get taxed twice, for corporation tax the fee income is treated as non-taxable in the hands of the PSC.

In addition, the PSC can onward pay to the contractor, without tax consequence, the fees that have been subjected to PAYE. These payments are tax-free in the hands of the contractor. They can be paid as salary, in which case they must be reported via the PSC’s payroll under RTI as tax-free and NIC-free, or as dividends (subject to Companies Act requirements).

Fee income received by a PSC outside the off-payrolling rules (ie, currently from private sector clients or prospectively from ‘small’ private sector clients) will not have had income tax and NIC deducted. When compiling the PSC’s accounts and tax computations for the year, it continues to be necessary for the contractor to assess whether or not those fees are deemed employment income under the IR35 rules and, if so, their PSC will need do the IR35 calculation and subject 95% of the fees to PAYE tax and NIC.

John Bull: a working example

Contractor John Bull’s PSC, JB ltd, contracts via Reputable Agency ltd to provide John Bull’s services to Mega Corp plc. Mega Corp plc’s SDS shows that John Bull would have been an employee if the contract had been direct between John Bull and Mega Corp plc. This is not disagreed by John Bull.

JB ltd invoices Reputable Agency ltd £6,000 fees and £1,200 VAT, totalling £7,200, for the services that are provided to Mega Corp plc.

From the fees invoiced of £6,000, Reputable Agency ltd deducts £1,650 (£1,200 tax at 20% basic rate plus £450 primary (employee) Class 1 NIC) (using 2019/20 NIC monthly thresholds and ignoring pence) which it accounts for under RTI to HMRC. Thus JB ltd receives a payment of £4,350 for John Bull’s services plus £1,200 VAT. Please note, if the invoice had covered two months, then two sets of monthly NIC thresholds would apply to the fees in Reputable Agency ltd’s payroll whereas one applies for tax as there is only one payment.

Once JB ltd has received those fees, JB ltd pays salary of £3,000 and a dividend of £1,350 to John Bull.

Reputable Agency ltd also accounts to HMRC for employer (secondary) NIC and AL in respect of the fees.

In JB ltd, ignoring all other income and expenditure, the accounts will show sales of £6,000, staff costs of £4,650 (comprising directors’ salary of £3,000 and PAYE of £1,650 withheld from fees paid under the off-payrolling rules), and dividends of £1,350. Thus, profit per accounts for tax purposes (ignoring other income and expenses) is £1,350.

JB ltd’s corporation tax computation can be drawn up as follows:

Profit per accounts		£1,350
Adjustment to remove non-taxable and non-allowable items relating to off-payrolling fee income:
Fee income	£6,000
Staff costs	(£4,650)
Total adjustment		(£1,350)
Profit chargeable to corporation tax		£Nil

The fees JB ltd receives under deduction of PAYE will be treated as taxable in the hands of John Bull as employment income from Reputable Agency ltd. The off-payroll working legislation allows JB ltd to deduct the amount of the fees received from its taxable income, so it is not taxed twice.

At the end of the tax year, John Bull should have received end-of-year forms P60 from Reputable Agency ltd (or will have received form P45 leaver statement if the contract has ended) and JB ltd. The Reputable Agency ltd P60 (or P45) will include gross £6,000, tax £1,200.

Assuming these are the totals for the year, John Bull should complete an employment page on his self assessment tax return for Reputable Agency ltd showing gross £6,000, tax £1,200. We await confirmation of whether any figures for onward paid fee income should be included by John Bull on the JB ltd employment page of his self assessment return in respect of off-payrolling income onward paid by JB ltd. Secondary class 1 NIC are not due on the payments paid through JB ltd’s payroll.

Is this the end of the PSC?

Will there still be a place for PSCs once the public sector regime for off-payrolling is extended to the private sector?

In the private sector, risk is as big a factor in business decisions as cost. While the off-payrolling rules have been operating in the public sector for nearly three years, the prospective rules for the private sector are uncertain and contain numerous trip hazards. These include:

• the need to determine employment status, which is a constantly evolving case-law test that even experienced judges can find perplexing;
• issuing an SDS that fulfils HMRC’s untested requirements of having taken reasonable care and providing reasons;
• setting up an SDS disagreements process; and
• ensuring that nothing happens in the labour chain that might result in the client involuntarily becoming liable to account for PAYE.

The new rules also require adequate lead time to change processes (eg, to separate fee notes into payroll and accounts payable/bought ledger elements), and redesign software, which in real life cannot be achieved at the drop of a hat, especially in a global business.

Clients might decide that only their most valued and skilled contractors whose (self) employment status is beyond doubt will continue to be hired individually via their PSCs, preferring to bring the general body of contractors onto payroll or into an agency-run managed service company or other arrangements. This may have implications for pay rates.

Further guidance available for members of the Tax Faculty 

• Webinar on 7 August 2019: Off-payroll working in the private sector – practical tips
• Webinar on 3 April 2019: Off-payroll working in the private sector – the consultation proposals
• TAXguide 16/19: 57 questions and answers arising from the faculty’s 7 August 2019 webinar
• TAXguide 14/19: Our current understanding of the prospective private sector rules
• TAXguide 10/18: Contract reviews – do the IR35/off-payrolling rules apply?
• Crystal Ball needed for PAYE 2020, TAXline, January 2020: Kate Upcraft explains the challenges in preparing payroll for the 2020/21 tax year
• Status update, TAXline, November 2019: Rebecca Seeley Harris recaps the tests for assessing whether IR35 applies

The topic is covered in various Practical Points included in TAXline and the IR35/off-payrolling hub.

About the author

Peter Bickley is technical manager at the Tax Faculty with responsibility for employment taxes and NIC