Off-payroll working: What’s it all about?

Peter Rayney looks at the current issues involving contractors and similar workers. 

The ‘original’ IR35 rules have been in place for over two decades and have proved a troublesome area for both HMRC and taxpayers. The ever-growing body of case law – recently affecting many high-profile TV and radio presenters operating through personal service companies (PSCs) - shows just how damaging this legislation can be.  
 
Gordon Brown introduced the IR35 provisions in 2000 to tackle ‘disguised employment’ arrangements where contractors or workers personally provided their services through a PSC. Despite the threats of its removal in recent years, IR35 and the off-payroll regime remain firmly alive and kicking! 

Typical PSC operating structure 

A typical PSC operating structure is illustrated below: 

Current operation of IR35 and off-payroll working rules 

The operation of IR35 has seen radical changes in recent years. The off-payroll working legislation has been ‘bolted-on’. Subject to one important exception for small business engagers, the engager or end-user (referred to as the engager for the rest of this article) of the services is responsible for applying PAYE and National Insurance contributions (NICs) where its relationship with the contractor or worker (working through a PSC) is deemed to constitute a deemed employment. This is determined by ignoring the PSC and imputing a hypothetical contract directly between the worker and the engager.  
 
The ‘exception’ to this treatment covers services provided to ‘small’ engagers (operating in the private sector). When the legislation was being formulated, it soon became recognised that it would be burdensome for smaller businesses to operate. Consequently, small businesses do not operate off-payroll working procedures. Instead, the PSC owner or worker determines whether the PSC’s contract or engagement with the end-user represents a deemed employment. If this is the case, the PSC must operate the original IR35 rules – thus, it would calculate the relevant net employment earnings (see below) and account for PAYE and Class 1 NICs on this.  

Determining whether a deemed ‘employment’ relationship exists 

Relevant end-engagers must make an accurate and robust determination of the worker or contractor’s ‘status’ and notify the reasoning for the decision. This provides an audit trail for HMRC in the event of an enquiry. The law requires the engager to take reasonable care when carrying out the relevant assessment. HMRC expects engagers, etc., to use its check employment status tool (CEST) – which is located online at www.gov.uk/guidance/check-employment-status-for-tax  

CEST asks a series of questions dealing with various factors that would normally be considered when determining whether an employment relationship exists, including worker’s duties, rights of substitution, degree of control, length of contract, working arrangements, financial risk and so on. Based on the responses, the CEST indicates whether the relevant engagement constitutes self-employment or employment. HMRC confirms that it will stand by the results obtained from CEST provided the relevant information is accurate and has been input correctly, and it is used in accordance with its guidance. 

If the engager has concluded that the relevant engagement is one of ‘employment’, it must provide the PSC worker with a status determination statement (SDS). Officeholders (such as directors, non-executive directors, and company secretaries) are treated in exactly the same way – i.e., they are treated as deemed employees and an SDS is still required. Where the SDS confirms that the engagement is one of employment or directorship, it must account for PAYE, Class 1 NICs – both employee’s and employer’s (currently at 13.8%) – and any Apprenticeship Levy (AL).  

If the SDS concludes there is genuine self-employment, the engager can pay the PSC gross. 

Where there is a multiple supply chain, the end-engager must hand down the SDS to the next party in the chain – this will often be an employment agency. 

Unfortunately, workers have no legal appeal process against an ‘employment status’ SDS. However, a worker or their PSC is entitled to disagree with the SDS by following the engager’s status disagreement procedure. The law requires the engager to reply to the ‘disagreement’ letter or notice within 45 days. The response must provide its reasoning and confirm that the original SDS was correct or issue a new SDS (of self-employment!). 

When the off-payroll rules were first rolled out, many businesses simply wished to avoid the potential tax risks dealing with status determinations. The solution for many was to offer their ‘PSC workers’ full employment contracts or a ‘blanket’ application of PAYE. 

Example 1: ‘Employment’ SDS 

Dido owns 100% of White Flag Ltd (her PSC), through which she provides her IT consultancy services. During 2023/24, she works on a six-month contract with Bounevialle Group plc (BG plc) (not a small group). 

On 1 May 2023, BG plc provides Dido with an ‘employment’ SDS – which she accepts. 
 
On 31 May 2023, White Flag Ltd invoices BG plc £6,000 (being £5,000 for IT services in May 2023 plus 20% VAT £1,000).  
 
When paying this invoice, BG plc deducts PAYE of (say) £1,000 (£5,000 x 20%) and employee’s NICs of £474, and accounts for this under the RTI process. The amount paid to White Flag Ltd is therefore £4,526, made up as follows: 

Example 2: Accounting entries 

Taking the facts in Example 1 above, a summary of the final entries in White Flag Ltd’s books to record the May 2023 invoice are as follows: 

Small business exemption 

Importantly, small businesses (operating in the private sector) fall outside the off-payroll working regime. They will simply pay the PSC gross and the PSC must then decide whether the engagement falls to be treated as deemed employment. If it does, it must account for PAYE and Class 1 NICs on the deemed net earnings in the normal way.  

The ‘small business’ exemption rules definition is broadly based on the lines of the Companies Act 2016 definitions. In a supply chain, the ‘small business’ exemption is only tested against the end-engager; the size of the other firms involved in the chain is irrelevant.  

Engagers or clients that have been asked by the PSC ‘worker’ to confirm whether they are ‘small’ must provide this confirmation within 45 days. This requirement is required to give certainty to the workers and others involved about the relevant tax rules that will apply. 

In the case of a ‘singleton’ company, it will qualify as ‘small’ provided it meets two of the three following conditions: 

• annual turnover of no more than £10.2 million; 

• gross balance sheet total no more than £5.1 million; or 

• average number of employees no more than 50. 

 
A singleton company is treated as ‘small’ for a tax year starting after the Companies Act 2006 accounts filing deadline for an accounting period in which it qualified as small. Companies that are part of a corporate group (involved in a joint venture or under common ownership) will not qualify for the small company exemption if the ‘consolidated’ group, etc., does not qualify as small.  

A different rule applies to other engagers, such as sole traders, partnerships, and overseas companies. They will always be ‘treated’ as small during their first tax year. In the following years, the business will be treated as ‘small’ if it satisfies the above Companies Act 2016 ‘turnover’ test only. 

Practical tip 

The recommended accounting treatment is for the PSC to record the gross amount (i.e., before PAYE or NICs deductions) as fee income, turnover or similar. The PAYE and NICs deductions should normally be shown as ‘staff costs’.