Off-Payroll Working for Contractors

The off-payroll working rules (commonly known as IR35) ensure that contractors working through their own limited company or other intermediary pay similar tax and National Insurance to employees when the working relationship resembles employment. If you're a contractor working through your own company, understanding how these rules work and who is responsible for applying them is essential for staying compliant with HMRC.

Who is responsible for IR35 decisions?

The responsibility for determining whether the off-payroll working rules apply depends on who your client is.

For small private sector clients, you (the intermediary, usually your personal service company) remain responsible for deciding whether the rules apply to each engagement.

For medium and large private sector clients, and all public sector clients, the client organisation is responsible for making the employment status determination and operating the off-payroll working rules. The deemed employer in the payment chain must deduct Income Tax and National Insurance contributions before paying you.

If you're not sure of your client's size, you can ask them to confirm whether they qualify as a small organisation. They have 45 days to respond.

Understanding the deemed employment payment

When you work for a small private sector client and the off-payroll working rules apply, you must calculate a 'deemed employment payment'. This is the amount treated as your employment income after certain deductions and employer National Insurance contributions have been removed.

You do not need to work out a deemed employment payment if you have already paid yourself employment income from the engagement that equals or exceeds the amount you received for that off-payroll work during the tax year.

How to calculate the deemed employment payment

HMRC provides a nine-step calculation process:

Step 1: Deduct 5% from your off-payroll income

Take the income your intermediary received from off-payroll engagements in the tax year (including non-cash benefits). Apply a flat rate 5% deduction for general expenses incurred in running the business. You do not need to prove this expenditure.

Step 2: Add payments made directly to the worker

Add any payments or benefits paid directly to you by the client (rather than to your intermediary) that would have been employment income if you were employed directly. Only include payments that were not paid by the intermediary and would not otherwise be taxable.

Step 3: Deduct expenses

Deduct expenses paid by the intermediary during the tax year that relate to the relevant engagements. These must be expenses you could have claimed as a deduction if you had been directly employed by the client. Include expenses you met personally and were reimbursed by the intermediary.

If off-payroll working rules apply, each engagement is regarded as a separate permanent employment for travel and subsistence expenses. This means you cannot claim expenses for travel and subsistence if you regularly commute from home to a workplace for an off-payroll engagement.

Step 4: Deduct capital allowances

You can only claim capital allowances if the plant or machinery bought is necessary for the tasks required by the engagement. You will only get relief if the duties of the engagement meant the intermediary had to provide the equipment. If the intermediary purchases equipment out of choice, you cannot claim the deduction.

If you use items for work outside off-payroll engagements, you must reduce the capital allowances by the proportion used outside those engagements.

Step 5: Deduct pension contributions

Deduct any contributions to an approved pension scheme made by the intermediary for your benefit.

Step 6: Deduct employer National Insurance contributions

Deduct any Class 1 and Class 1A National Insurance contributions paid to HMRC by the intermediary in the tax year on the salary and benefits paid to you. For example, if the intermediary is liable to pay £3,500 employer Class 1 National Insurance contributions but claims the full £4,000 Employment Allowance, it would only pay the balance of £500 to HMRC. This £500 is the amount used in this step.

Step 7: Deduct salary and benefits already paid

Deduct the amount of salary and benefits paid by the intermediary to you that has been taxed as employment income. If the figure is nil or negative, there is no deemed employment payment and no further employment taxes to pay.

Step 8: Deduct employer National Insurance contributions on the deemed payment

Calculate and deduct the amount of employer National Insurance contributions on the amount from Step 7. This gives you the deemed payment.

Step 9: Pay tax and National Insurance contributions

Pay and report Income Tax and National Insurance contributions due on the deemed employment payment.

Reporting and payment obligations

If you make salary payments to yourself during the year, report them to HMRC on a Full Payment Submission on or before the time of payment. If you do not make salary payments, return an Employer Payment Summary.

The deemed employment payment should be reported on a Full Payment Submission on or before 5 April each year. You must include the deemed employment payment on a P60 form, which you must issue to yourself by 31 May after the end of the tax year.

If you cannot accurately work out the deemed employment payment by the end of the tax year, you have until the following 31 January to submit final figures and pay any balance of tax and National Insurance contributions due. To use this extension, you must:

Report a provisional calculation on a Full Payment Submission on or before 5 April
Make the appropriate payment of tax and National Insurance contributions to HMRC
Report final figures on an Earlier Year Update or further Full Payment Submission submitted on or before 31 January following the end of the tax year
Pay a balancing payment of any additional tax and National Insurance contributions due by that date

Interest will be due on the balancing payment but not a late payment penalty. HMRC reviews this concession annually.

Self Assessment and other tax considerations

The deemed employment payment is treated as your employment income from the intermediary. Include it with any other employment income on your Self Assessment tax return. The pay, tax and National Insurance contributions detailed on your P60 should include the deemed employment payment as well as tax and National Insurance contributions paid on it.

When you work out Corporation Tax liability, deduct the amount of the deemed employment payment and Class 1 employer's National Insurance contributions due on it. This deduction is only allowed when you work out the taxable profits for the accounting period in which the deemed employment payment is treated as paid.

The fees you charge for providing services remain subject to VAT, even if the engagement is within the off-payroll working rules. This is because your intermediary is still the entity contracting to provide services to the client.

Working with medium, large or public sector clients

If you provide services to a public sector client or a medium or large-sized client outside the public sector, you should receive an employment status determination from the client, along with the reasons behind that determination.

If the client determines you are inside the off-payroll working rules, the deemed employer in the payment chain is responsible for deducting Income Tax and employee National Insurance contributions and paying them to HMRC, along with employer National Insurance contributions and Apprenticeship Levy.

Your payment will arrive with Income Tax and National Insurance contributions already deducted. When you pay yourself from the intermediary, do not deduct Income Tax or National Insurance contributions again. You can pay yourself either as a salary through payroll (without further deductions) or as dividends (which do not need to be recorded on your Self Assessment return). This avoids double payment of Income Tax or National Insurance contributions.

Disputing a status determination

If you disagree with a client's employment status determination, you can challenge it. You need to give details of the determination you disagree with and your reasons for disagreeing. Keep copies of any records about disagreements. You can raise a disagreement until the last payment is made for your services.

The client has 45 days from receiving your disagreement to respond. During that time, the deemed employer should continue to apply the rules in line with the client's determination. If the determination changes, the client must give you a new status determination and confirm when it is valid from.

Multiple workers

If you supply the services of more than one worker to a client under the same contract, you must work out the deemed employment payment separately for each worker. If a client makes a single payment for two or more workers for different engagements, the income received must be split proportionally.

Sources

This article provides general guidance based on current HMRC rules. For advice specific to your situation, speak to your accountant.