Owner Kate Upcraft Consultancy Ltd
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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.

13th Sep 2019
Owner Kate Upcraft Consultancy Ltd
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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.

Mixed economy

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?

Inside IR35

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.

Human Resources

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.

Finance

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

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.

Replies (14)

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By Rgab1947
16th Sep 2019 09:39

However you look at it IR35 its a disaster. Complex, unfair and impractical. Just what HMRC seems to like

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Replying to Rgab1947:
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By addamwalker
16th Sep 2019 09:54

I disagree, IR35 is long overdue, why shouldn't contactors have to pay the same amount of tax as the rest of us? Thing is, once we get their effective tax rate to around 5% they still moan about it!

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Replying to addamwalker:
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By IANTO
16th Sep 2019 10:28

Employees pay no tax on the benefit in kind of holiday pay, sick pay and any pension contributions. It is claimed that contractors receive extra remuneration to compensate for the lack of employment benefits, but that remuneration is taxed. If we are to have a level playing field, then employees must pay tax on their benefits in kind. It's only fair that employees pay the same taxes as contractors.

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Replying to IANTO:
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By matttaxnpayroll
16th Sep 2019 10:55

Employees DO pay tax on holiday pay, and sick pay, and contractors get the same tax relief as employees on pension contributions, albeit possibly in a different way. Contractors usually get paid more because there are less associated costs - employer's NI, pension, holiday pay etc.

However, these two groups are not the same - contractors take on greater risk by running their own company, or being self-employed, need to complete more admin and therefore can claim expenses employees cannot, thus paying less tax.

I don't see why we should see a need to equalise groups who are clearly different.

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Replying to matttaxnpayroll:
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By IANTO
16th Sep 2019 12:16

"I don't see why we should see a need to equalise groups who are clearly different." but this is exactly what HMRC is trying to do with IR35. "It is only fair that two individuals doing the same job should pay the same amount of tax irrespective of their individual situations"

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Replying to IANTO:
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By matttaxnpayroll
02nd Oct 2019 10:12

My point exactly. If HMRC want them to pay tax/NI as an employee, just make them be an employee, rather than create this over-complicated faff. Can't someone refer them to their Office of Tax Simplification?

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Replying to matttaxnpayroll:
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By IANTO
18th Oct 2019 08:18

Under the new rules proposed for April 2020, contractors will not be able to mitigate their tax bills by having pension contributions deducted from gross income prior to taxes being applied, just as employees do. We are still seeing the argument from HMRC that a contractor earning the same income as an employee, should pay the same taxes. This will not be the case from April 2020. Furthermore, note that the justification for applying IR35 of "doing the same job" has now changed to "earning the same income".

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Replying to addamwalker:
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By cereus77
16th Sep 2019 11:11

I don’t understand what you mean when you say that “IR35 is long overdue”. This ill considered legislation has been around for a couple of decades - this is merely the latest lazy attempt at making it work as HMRC believe it should.

If a contractor is really effectively an employee working for years at the same client then I agree that they should be treated the same but that would include getting all employee benefits as well as paying the same taxes. However this seems to be a situation which HMRC already have full power to identify and tax accordingly.

One of the biggest problems with this latest bright idea is that it means genuine self employed contractors who travel from one short term assignment to another will be unable to claim their business expenses, which can be very significant. For me this is an absolute non starter.

HMRC already solved the supposed employee/contractor tax difference with their poorly thought out dividend tax in 2017 - anyone forced to use a limited company as I am (the unintended consequence of earlier HMRC IR35 efforts) now pays 6% extra on top of income tax across all their dividend income.

I’ve contracted in the UK and Europe for the last 20 years navigating through the increasingly onerous tax legislation. Brexit permitting; I will only be taking work in mainland Europe from next year and paying taxes in whichever country I am temporarily based. I do hope that HMRC have factored this kind of reaction into their cost benefit case.

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By dmmarler
16th Sep 2019 11:05

It is a complete nonsense. If only some politician had the guts to get rid of NI completely and incorporate the % into income tax we could have a simple and fair system. People who are only limited company contractors to avoid NI ers charge would disappear and those who want to be limited for other reasons will remain, and the commercial contracts between the parties will be all that is relevant. Yes, accountants/consultants are making a killing out of the present stupidities but that is not good for the country. Nor is keeping a raft of civil servants together with their pensions, office accommodation, computer systems, etc., helpful for the economy.

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Replying to dmmarler:
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By cereus77
16th Sep 2019 11:25

I agree in general with your point but I’m not sure whether any contractors are working through a PSC to avoid employers NI. I believe this was an initial reason why so many large companies transformed employees into contractors in the late 1990s and early 2000s but this was saving the large company money not the contractor.

It is this implicit wrong assumption that seems to underlie much of HMRCs efforts in this area. If this latest IR35 amendment goes ahead as planned they will now be taking employers NI out of the contractors’ remuneration when it was never there in the first place!

I expect there are many contractors like me who would be happy to pay a single NI charge just as sole traders do but of course are not happy to pay the employers NI across all income from their PSC when in fact that element of remuneration is not there in the rate but is a saving made by the large companies who from time to time employ us on their projects.

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By vstrad
16th Sep 2019 11:23

"Deemed employees have no employment rights …". I expect it won't be long before a challenge in the courts reveals that they do.

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Replying to vstrad:
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By IANTO
18th Oct 2019 08:22

Let's hope so. Clients will then hopefully wake up to the issues and ensure that contractors are truly self employed.

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By dgilmour51
16th Sep 2019 11:39

A further issue is that the status of 'employee' is
a. temporary
b. by gig
There are on-going costs that are borne by Ltd.Cos that must still be paid even if a gig is deemed employment - one example being Professional Indemnity and, of course, CoHouse fees etc.
Typically PI has to be held for up to six years after the relevant gig lest some misfeasance be detected after gig-end.
Whilst, as an employee, PI is not needed the expense still has to be borne.
The answer, of course, is to make all employees also carry PI individually and that it not be tax deductable. Perhaps a Government scheme could be set up, like with Pensions . . .

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By chris_hustwayte
17th Sep 2019 18:54

In HMRC's headlong charge to collect more Tax and NI I wonder whether they have considered the loss of revenue due to the inevitable closure of specialist contractor accountant firms, professional indemnity insurance providers and the raft of other suppliers to PSCs, as ten of thousands of PSCs are closed and contractors switch to umbrellas or employees. The impact on Public sector PSCs was relatively small since they could change the Private sector. This time there will be nowhere to hide.

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