From ‘off-payroll’ to on-payroll: It’s not simple
Kate Upcraft reviews some of the practicalities of handling the withholding of tax by engagers or fee-payers from contractors’ fees, which isn’t covered in the HMRC guidance.
HMRC recently published the first tranches of their new off-payroll guidance. Rebecca Cave provided an overview of that guidance, which has different strands for engagers, intermediaries and fee-payers. However, there is nothing in the guidance which addresses the needs of payroll agents and managers.
While there are large cohorts of specialist contractors who are sourced and paid through agencies, at the lower end of the engager size spectrum there are many direct engagements where the contractor is paid by the engager. We are therefore dealing with a multi-layered fee-payer population.
Many of you will work in accountancy practices that offer payroll services to medium and large engagers and also to the PSCs of the contractors. These payroll agents sit at the end of the process and not the beginning, so they are another layer in the supply chain.
Business process or payroll process?
The answer is both. Undoubtedly, the status assessment and issuing of the SDS (Status Determination Statement) does not fall to an internal payroll team or an external payroll agent. Some accountancy practices may offer employment status expertise, in which case there is a fee-earning opportunity here.
Accountancy practices should review their letters of engagement for payroll services to make it clear what service they are offering in respect to the “deemed employee” population. Does the work involved in withholding tax and NI for deemed employees require a different fee strategy than for actual employees?
I’m going to focus on what occurs once the contract is deemed inside IR35. There are Human Resources (HR), finance and payroll processes that need to accommodate this new type of payee.
HR will need to capture the personal details that turn an invoice from an intermediary into an instruction to pay an individual. Can they bypass the HR systems and create a record for payroll purposes only? Deemed employees have no employment rights (to pensions, NMW and statutory payments) so they need to be excluded from any automated HR processing in this regard.
This department needs to work out how to ensure that a VAT inclusive invoice can be reduced once tax and NI have been deducted.
Some public sector bodies have put VAT and any allowable expenses through payroll too as non-taxable/non-NI’able in order to provide for one (albeit reduced) payment to the contractor, rather than VAT and expenses being paid via finance and net fees via payroll.
The decision on reconciling VAT will be finance system dependent and should not be underestimated as part of the off-payroll challenge!
Payroll managers or agents need to create a payroll record that does two things:
- For national insurance, they must assign a table letter as if the PSC were a real employee: for example, under 21, over state pension age etc.
- For income tax, they must use the starter declaration C on the starter checklist and allocate a tax code: BR. HMRC has always insisted that this is what it wants rather than the more appropriate 0T/1 code. It is not clear what should happen if the contractor presents a completed form P45. Does that P45 override HMRC’s default position?
Payroll must treat the fee as taxable and NI’able and therefore subject to the apprenticeship levy.
It must also set the new “off-payroll worker” marker in the Full Payment Submission. While it is welcome that after two years HMRC has agreed to include this in RTI from April 2020, we still don't know whether this marker needs to be set every time the deemed employee is paid. We don’t know what happens if it's set in error against an actual employee, or what happens if the payroll agent forgets to set it the first time they pay someone.
These are the types of operational issues that are outstanding.
How do we pay deemed employees?
Once the engager has issued an “inside IR35” SDS the key thing the contractor wants to know is “when will you pay me and how much?’
‘When’ will be dictated by payroll runs as opposed to accounts payable deadlines, so that needs agreeing. The alternative is to have an additional “deemed employee-only pay run”, with additional cost for payroll agents and their clients.
And who has the bank details in order to make the physical payment and get a payslip to the contractor’s PSC? There is no legal right to a payslip as the director of PSC isn't a worker or employee, but you can imagine most contractors will want some sort of document to support the deductions ahead of an end-of-contract P45 or end-of-year P60.
How do we pay PSCs?
Agents will be paying deemed employees but will also be running the payroll for PSCs when it pays the PSC director. Most single-director PSCs will have an annual PAYE scheme and typically take one amount in March to protect their NI record. When this payment is processed it’s reported on the FPS as non-taxable/non-NI’able up to the value of the deemed income already taxed by any fee-payer.
Any income withdrawn that relates to small engagers should still be considered from an IR35 perspective by the PSC and treated as a deemed payment if required.
In the director’s personal tax account there will be two income sources: employment income reported by the fee-payer with tax and NI shown, and a second income stream for the PSC that will show as nil unless any income was treated as a deemed payment by the PSC.
If the private sector agencies, businesses and payroll agents, are going to be ready for April 2020 we need a lot more discussion and detail on all the operational issues as well as the final legislation.
I hope the HMRC’s Employment Status Manual gives us that detail, but it needs to appear soon.