What Is Off-Payroll Working?

Off-payroll & IR35: What is the impact on payroll teams?

Dierk Russell | Business Development Manager, CloudPay

IR35 is a subject that often arises for companies, workers, and payroll teams across the United Kingdom, partly because it often causes so much confusion.

But not only is it important to fully understand how it works, that importance has been raised even further due to some recent rule changes. Given that HMRC has been successful in pursuing IR35-related tax avoidance through the courts - in one case, resulting in an order to repay more than £400,000 - now is the time to make sure you’re up to speed.

This blog will outline the key facts around IR35, what has changed more recently, and what payroll teams can do to ensure IR35 compliance.

What is IR35?

IR35 is legislation in the UK designed to clamp down on tax avoidance. It targets contractors, freelancers and ‘disguised’ employees who work full time for a company through an intermediary, rather than being employed by the client company directly.

For example, a contractor may work with one company over normal full-time hours. But instead of being contracted directly, with all the usual tax implications for both employee and employer, the work is instead contracted out through an intermediate company, usually a personal services company (or umbrella company). The contractor can then draw the earned money out of their PSC as dividends, meaning they only have to pay corporation tax at 19% and the relatively low dividend tax rates. This can potentially save them thousands of pounds a year, and saves the employer money by not having to make National Insurance contributions for that worker.

The key distinction that HMRC takes into account when deciding whether someone is inside or outside IR35 is what their arrangement would be if the intermediary didn’t exist. If they would be employed directly by them instead (because the umbrella company between them has been removed), then they are inside IR35. That means they are ‘off-payroll’ and subject to all the income tax and National Insurance payments that would be applied to a normal full-time employee.

Because of this, in most cases, contractors and freelancers with one client - or who only work for one client at a time - tend to fall inside IR35, while those who deal with several different clients tend to be outside. However, these are general trends and not necessarily applicable to every case.

Why is IR35 so important for payroll teams in 2022?

All that makes IR35 sound relatively simple. The problem, however, is that applying the legislation isn’t always straightforward - and now a new development has made things even more challenging.

Previously, contractors working with private-sector clients could decide their employment status themselves. But as of the start of the 2021/2022 tax year, large and medium-sized private businesses must also assess their relationships with contractors in the context of IR35. In this case, this applies to any companies that meet at least two of three criteria: turning over more than £10.2million a year, having a balance sheet total of more than £5.1million, or having more than 50 employees.

This change was introduced on April 6 2021 and businesses were given a year’s grace where penalties for non-compliance wouldn’t be levied by HMRC. But that has now ended, and so any of these companies who incorrectly assess a contractor to be outside IR35 when they are in fact inside - in the view of HMRC - will face stiff sanctions. These include collecting all relevant PAYE and NI monies due, plus interest, and a potential doubling of that total as a fine. 

Ultimately, it will be down to payroll, finance and HR teams to ensure IR35 compliance and make the relevant assessments. And so payroll has a vital part to play in protecting the wider business from legal and financial sanctions.

How can payroll teams maintain IR35 compliance?

Because of the potential impact of non-compliance and the extra pressure that HMRC is applying, payroll teams have a lot of work to do. There are a number of elements for payroll teams to keeping everything above board when it comes to IR35:

• Deductions: taking the right income tax and NI contributions and reporting directly to HMRC through the Real-Time Information system
• CEST tool: using HMRC’s Check Employment Status for Tax tool to determine the IR35 status of a contractor
• RTI flag: setting the status of a worker to off-payroll within the RTI system, so HMRC is aware of the arrangement (this also helps ensure that student loan payments aren’t deducted)
• Payroll status: adding the contractor to the normal payroll cycle alongside normal salaried employees, so they are paid on time, accurately and with the right tax codes and deductions in place.

In summary

The reforms to IR35 have caused challenges to many organizations, both public and private. Indeed, even  government departments have been fined hundreds of millions of pounds for incorrectly implementing the revised legislation. 

Nonetheless, it’s essential that companies - and their payroll teams - are getting their IR35 assessments and compliance exactly right. With HMRC being increasingly rigorous in their application of the rules, and with the fines for non-compliance potentially huge, now is the time for every business to review its contractor hiring processes to make sure everything is above board.

The expert team at CloudPay is here to help you understand IR35 from your own perspective and ensure you stay fully compliant. Get in touch with us for a friendly chat today.

Dierk Russell | Business Development Manager, CloudPay