Running an IR35-compliant payroll

We appreciate that running an IR35-compliant payroll is difficult. The new off-payroll working rules have made compliance even harder and shifted significant financial risk over to your business or organisation.

In this article, especially written for HR, finance and procurement staff looking for a 5-minute refresher on IR35, we cover:

What IR35 is
What your responsibilities are
Paying contractors inside and outside IR35

For more information on IR35 compliance for employers, please call CoComply on +44 (0) 203 051 9792, email [email protected] or fill out the form below.

IR35 – what it is and where we are now

HMRC believes that thousands of employers and hundreds of thousands of contractors actively collude with each other on an ongoing basis in a widespread tax avoidance scheme relating to employment status.

How this “tax avoidance” scheme works

They believe that off-payroll working is a way for employers to duck out of their responsibility for deducting income tax and National Insurance. They do this by dressing up “disguised employees” (or “deemed employees”) as self-employed independent contractors.

These disguised employees set up their own limited company (often called a personal service company) and they send their employer invoices instead of getting their wages via payroll like standard part- and full-time employees.

IR35 status jargon

Under the off-payroll working rules, a contractor is said to be:

Inside IR35 if the contract they have with an employer and their actual working practices closely resemble that of a standard employee
Outside IR35 if the contract and working practices are similar to that of a standard customer-supplier relationship.

How employers and contractors win under this arrangement

If a contractor is outside IR35, you don’t have to pay Employer National Insurance contributions, equivalent to 15.05% on top of the gross salary. You also don’t have to make pension contributions or pay the Apprenticeship Levy.

You don’t have to abide by standard employment law either. There are no costly employee benefits like statutory payments, sick pay and holiday pay.

Contractors don’t pay income tax and National Insurance contributions, unless they want to (which they never do for all the right reasons).

Their limited company pays corporation tax at 19%. Contractors, in their role as shareholding directors, pay themselves just up to the annual personal allowance sometimes drawing minimal employer NICs payments but never any income tax or personal NICs. Anything over and above the annual personal allowance is paid in dividends which has its own annual £2,000 allowance and is charged at much lower rates than standard income tax.

If a contract is inside IR35, income tax, both forms of National insurance, pension contributions and (if applicable) the Apprenticeship Levy must be collected and paid by the employer. If a contractor is inside IR35 and comes via an umbrella company, they have to pay employers NICs which you end up paying for through higher rates.

The incentive for contractors to be outside IR35 is that, if they earn £100,000 a year through their limited companies, they’ll pay HMRC £20,000+ less than an employee on the same salary.

And HMRC doesn’t like this.

Responsibility for and risk from employment status determination has now transferred to you, the employer

Before now, contractor IR35 self-determination was in force. If a contractor got their status for tax purposes wrong under the off-payroll rules, they bore the financial responsibility for it.

Now, it’s your responsibility if you represent a:

Public sector body
Private sector company with an average annual turnover of £10.2m over the last two consecutive financial years

CoComply note – contractors still self-declare under the new off-payroll rules when providing services to small businesses.

End clients and fee payers

Under the law, your business or organisation is the “end client” as you directly benefit from the services provided by your contractor.

If you pay your contractor’s invoice as well, you’re also classed as the “fee payer”. If you hire contractors through a recruitment agency and they pay your off-payroll worker, then they are the fee payer.

CoComply note – all contractors paid via an umbrella company are deemed to be inside IR35.

Creating a status determination statement

You must create a status determination statement for all off-payroll workers.

Status determination is the process by which you decide a worker’s tax status. This is a complex area of employment case law and you need to take care with it.

Among many other factors, you have to consider when determining employment status:

Independence. How free is your contractor to perform their role? The more you manage what they do including telling them where and when they should work, the more likely HMRC will consider them as a disguised employee.
Financial risk. Is your contractor responsible for paying for any mistakes that cost you money? Have they taken out business insurance to cover their liability?
Substitutability. If you require a contractor to carry out the work themselves and you don’t permit them to send in someone else to do the work, they are more likely to be inside IR35.

You need to send a copy of your status determination statement to your contractor prior to work starting under IR35 rules. You must also send it to all others in the supply chain like recruitment agencies.

CoComply note – the situation around seconded contractors is particularly complicated and you should take advice from an expert. This is applicable to companies placing part-time and fractional directors within other companies.

Contractors may also appeal against your IR35 decision

Genuine contractors object strongly to these new rules. They value their self-employment status and want to continue enjoying the benefits of providing their professional services in an independent capacity. They also don’t want to have to pay tax at a higher rate than they need to.

Contractors deemed as being inside IR35 can appeal against your decision if they believe their outside IR35.

To attract the best contractors to work for you, take care in determining IR35 status every time. Don’t use blanket or role-based IR35 assessments and try to avoid using HMRC’s CEST tool as it’s buggy and unable to determine IR35 status in one in five cases. If you do, they’re almost certain to appeal or reject your offer of work.

Contractors may lodge an appeal against the IR35 status you give them until they have received their last payment. Although you are under no legal requirement to change your mind on a contractor’s status, you do have to provide an answer to their appeal within 45 days.

Paying contractors inside and outside IR35

How you pay your contractors will depend on the IR35 status you have given to them.

Outside IR35

You should pay invoices to a contractor’s limited company direct or to their recruiter if applicable.

Inside IR35

If your contractor is inside IR35, you’re responsible for calculating income tax, both forms of National Insurance and, if applicable, the Apprenticeship Levy.

You also need to:

Post a full payment submission under the Real Time Information system of your payment to the contractor’s personal service company
Issue a P60/P45 at year end if applicable

You should not make statutory payments, auto-enrol the contractor for a workplace pension or deduct student loan payments.

CoComply note – use the OPW worker flag in the RTI system for all deemed employees

Take control over the new off-payroll working rules

Being an outside IR35 contractor is tax efficient. Contractors don’t want to become deemed employees because the drop in take-home pay they suffer is significant. They want their fees paid in full, just like before.

With CoComply, you can create a welcoming, friendly outside IR35 environment for off-payroll workers giving you the chance of attracting the best talent at a significantly lower cost.

To find out how we can bring in all existing and future outsourced contract work outside IR35, get in touch with us today.