The off-payroll working rules, known more commonly as IR35, were introduced in 2000 to tackle what HMRC called ‘disguised employment’. Some contractors and employers took advantage of the tax efficiency of working through a limited company, even though the contractor was effectively working under an employee relationship. This avoided National Insurance costs and saved Income Tax.

Traditionally it was the contractor’s responsibility to assess their employment status and pay tax and national insurance through their own limited company as if they were an employee of their client.

HMRC would then occasionally review these agreements to ensure the correct treatment was being applied by the contractor and challenge where necessary, often resulting in a very nasty and unexpected tax bill.

There are two tests that HMRC need to prove:

  1. There is an individual working through a limited company providing services to an end client
  2. That the limited company was only formed to avoid that individual being an employee of the end client and without their company they would be an employee. HMRC will assume, assert and argue this is the case

Although the legislation has been around for almost two decades, HMRC claimed that levels of non-compliance have been high, with only 10% of those who should be applying the rules doing so.

To combat this, reforms were announced to shift the responsibility of determining IR35 status from the contractor to the end client. This change was implemented in two stages:

  1. From 6th April 2017 it applied to work performed under contracts in the public sector
  2. From 6th April 2021 it also applied to work performed under contracts in the private sector

What do the latest changes mean?

Let’s take the example of an IT Contractor, Joe Bloggs, who has a contract to work through his Limited Company, Bloggs IT Limited, providing services to ABC Bank PLC (the end client and engager).

Joe Bloggs ——-> Bloggs IT Limited ——-> ABC Bank PLC

Prior to 6th April 2021, it would have been up to Joe Bloggs to decide whether this contract was caught by IR35.

For services performed from 6th April 2021, it is now down to ABC Bank PLC to determine, as they are a ‘Large Engager’.

To be a ‘Large engager’ they must meet at least two out of these three tests:

  1. Turnover – more than £10.2 million
  2. Balance sheet total assets – more than £5.1 million
  3. Number of average employees – more than 50

If engager is an individual or partnership, only the turnover test applies to consider whether they are large.

If the engager is deemed to be small, it will remain the contractor’s responsibility to determine their IR35 status.

Many of these types of contracts are in place between much smaller contractors and large businesses and so those contractors may now find their tax status being changed.

What happens if a ‘Large Engager’ decides your contract falls under IR35?

The process will likely be as follows:

  1. They will issue you with a ‘Status Determination Statement’
  2. If you agree with their determination you will accept
  3. If you disagree (and it is quite possible they will get this wrong) you can appeal, and the Large Engager has 45 days to review and either remain with their original determination or change it
  4. You will be asked to provide your personal details as if you were an employee so that you can be added to their payroll
  5. You will then raise an invoice for your fees (plus VAT where applicable) from your Limited company as normal
  6. The Large Engager will then deduct PAYE and National Insurance from your fees and pay the net amount to you along with any VAT charged
  7. The net amount received into the Limited company is treated as your ‘deemed employment income’, so you will not have to pay Corporation tax on this amount in your Limited company
  8. The amount will need to be declared as tax-free salary on your Limited company’s payroll
  9. At the end of the tax year, the Large Engager will issue you with a P60 and these figures will need to be declared on your personal self-assessment tax return

What if you work through an agency?

This works in the same way and it is the end client’s responsibility to give you Status Determination Statement, as well as to the agent. If there are multiple agents in the chain, they are responsible for passing this down the contractual chain until the final business who will be paying your Limited company receives it.

Where there is non-compliance with the new rules, the PAYE and National Insurance Liabilities will lie with the business that failed to meet its obligations.

Example: Brown Limited

Mrs Brown works through Brown Limited and contracts with the NHS through an agency.

Brown Limited raises an invoice to the agency for £50,000 and the agency raises an invoice to the NHS for £60,000 (£50,000 plus their £10,000 profit).

The NHS decide that Brown Limited is caught by IR35 and issue a Status Determination Statement to Brown Limited and the agency.

The NHS will pay the agency their invoice of £60,000. The agency will then deduct PAYE and National Insurance on the £50,000 payment to Brown Limited (in the example say £15,000 in total PAYE and National Insurance). They will then pay the remaining £35,000 to Brown Limited.

Brown Limited will not pay any further Corporation tax on the £35,000 and can pay this out as tax-free salary to Mrs Brown.

Mrs Brown will receive a P60 from the agency, the figures from which will need to be included on her self-assessment tax return.

How do you account for this in your bookkeeping software?

Generally, we would suggest the following:

  1. Create an account under sales for each client called ‘Net income from …’
  2. Create an account under expenses for each client called ‘Deemed salary from…’
  3. Post a sales invoice for your full fees (plus VAT, where applicable) to the new sales account
  4. Post a sales credit note for the PAYE and NIC deductions, with no VAT, to the new sales account
  5. Post a journal for the deemed salary (the net amount after PAYE and NIC deductions excluding VAT) by debiting the new account for ‘Deemed salary from…’ and crediting the Director’s Loan Account
  6. When you receive the payment into the business bank account, allocate it against the sales invoice to settle the balance
  7. When you draw the income out of the business bank account, post a bank payment to the Director’s Loan Account

What can we do to help you?

  • If you are considering accepting a contract which may get caught by IR35, we can review the contract advise whether it is likely to caught and suggest what changes could be made to avoid IR35
  • Help you appeal against Status Determination Statements which are incorrect
  • Advise you on how to correctly account for your IR35 income in your bookkeeping software
  • If you are a Large Engager, we can help you look at alternative arrangements for certain contractors

Want to find out more?

Call us on (01474) 853856 and we will put you in contact with one of our advisers, or send us an enquiry by clicking below.

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