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Don’t get caught out by IR35 and off-payroll working

Floorlayers working through their own companies, and the contractors they work for, need to ensure they are on top of off-payroll working and IR35 rules as mistakes can prove costly, says Emma Rawson.

MISTAKES can be costly when floorlayers working through their own companies, and the contractors they work for, don’t ensure they’re on top of off-payroll working and IR35 rules. The problem relates to what is termed ‘disguised remuneration’ and the avoidance of tax. It’s a subject that HMRC is very hot on.

The rules laid out
In essence, the off-payroll working rules are intended to ensure floorlayers, and the firms that hire them, can’t save tax by introducing an intermediary into their contractual arrangements.

For example, a contractor wishing to take on help could choose to engage an individual directly. If they were classed as an employee for tax purposes, the contractor would have to operate PAYE and would also be liable for employers’ NICs.

Alternatively, the contractor could contract via a company owned by the floorlayer (often referred to as a personal service company or ‘PSC’ for short). In the absence of the off-payroll working/IR35 rules, the floorlayer could end up with a lower tax and NIC bill, and the contractor wouldn’t need to worry about employer NICs or operating PAYE.

To tackle such arrangements, over 20 years ago the government of the day introduced a set of rules which are often referred to as ‘IR35’. Under IR35, the floorlayer has to decide if, ignoring their PSC, they would have been an employee of the contractor. If they would, the PSC has to account for the appropriate payroll taxes and NICs to HMRC.

Following longstanding concerns over the level of non-compliance with IR35, new rules (referred to as ‘off-payroll working’) were introduced for the public sector in April 2017 and the private sector in 2021.

Under off-payroll working, the responsibility for deciding on whether or not a floorlayer should be taxed as an employee is taken out of their hands. Instead, it is up to the contractor to determine whether the rules apply and ensure the correct payroll taxes and NICs are deducted from payments made to the PSC.

Which rules apply?
Despite the off-payroll working rules now applying across the public and private sector, the old IR35 rules haven’t disappeared.

In particular, floorlayers still need to consider IR35 if the contractor they’re working for is either based wholly overseas or classed as ‘small’. For these purposes, unincorporated clients such as sole traders or partnerships will be small if their turnover does not exceed £10.2m.
Contractors that are companies or LLPs need to meet the Companies Act definition of a small company which broadly requires any two of the following – turnover not exceeding £10.2m, assets not exceeding £5.1m, and no more than 50 employees.

When do the rules apply?
The off-payroll working and IR35 rules work in very similar ways. The key difference is who makes the decision and is responsible for deducting tax and NICs.

Under both regimes, there needs to be:
An individual worker performing services for a client;
Instead of the client directly engaging the worker, those services are provided through an intermediary (such as a PSC or, less commonly, a partnership); and
If the worker had been contracted directly by the engager, they would have been regarded for tax purposes as an employee.

The first two of these conditions are relatively straightforward, but the third is much trickier. In effect, you have to imagine there is a direct contract between the worker and client, and consider whether that contract would have been one of employment. If the worker would have been self-employed then off-payroll working/IR35 don’t apply. If they would have been an employee, then the rules apply.

What contractors should do
The first thing for contractors to check is whether they qualify as ‘small’. If they are, they have no further obligations under the off-payroll working rules, and it will be up to the floorlayer to worry about IR35 instead.

If they’re not small, they need to carefully check their contracts with floorlayers and others they use. If any aren’t directly with the individual or an agency, but instead through a PSC or other intermediary, then the off-payroll working rules need to be considered.

For each contract potentially in scope, the contractor needs to consider whether, if the floorlayer was engaged directly, they would be considered to be an employee for tax purposes. HMRC’s Check Employment Status for Tax tool on GOV.UK offers help with this. It’s important to take reasonable care in coming to this decision, as if not the contractor could be on the hook for any tax due, as well as possible penalties and interest.

Contractors then need to issue a document known as a status determination statement (SDS) setting out whether or not they think the off-payroll working rules apply and their reasons. A copy of the SDS needs to be given directly to both the floorlayer and any agency the contractor uses.

If off-payroll working applies, then whoever pays the floorlayer’s PSC will need to operate PAYE and deduct tax and NIC from those payments. Depending on the exact contractual circumstances, this could be the contractor itself or an agency.

Either way, contractors need to ensure they have procedures in place to monitor all contracts entered into with floorlayers, issue an SDS and deduct tax and NICs as needed.

What floorlayers need to do
If a floorlayer enters into a contract to provide their services via a PSC or partnership, they should first check whether or not the contractor they will work for is ‘small’. Floorlayers should ask the contractor this question directly – while there’s no specific requirement for small contractors to inform floorlayers of their status, they do have to provide an answer if asked.

If the contractor is small, the floorlayer will have to consider whether the IR35 rules apply and ensure their PSC accounts for PAYE and NICs accordingly.

If they’re not small, the floorlayer should receive an SDS from the contractor setting out their conclusion as to whether or not off-payroll working applies and the reasons for this. This should be checked carefully for accuracy, especially any statements made regarding the contractual or working relationship.

If the rules do apply, payments made to the floorlayer’s PSC will be net of tax and NICs. This could give rise to cash flow problems. However, the PSC won’t pay corporation tax on the amounts it receives, and the floorlayer will be free to extract the funds as a dividend or salary without paying any additional tax or NICs.

If the floorlayer and contractor disagree
If a floorlayer disagrees with the contractor’s conclusion as to whether or not off-payroll working applies, they can ask them to reconsider. The contractor then has 45 days to either uphold their original decision or issue a new SDS. Contractors need to ensure they have procedures in place to handle such disagreements and turn them around within the deadline, or they will remain liable for deducting tax and NICs.

Unfortunately, if the floorlayer and contractor continue to disagree there is little more that can be done. HMRC will not intervene to settle any disputes and instead, the floorlayer and contractor will have to decide whether they wish to continue or walk away from the contract entirely.

Dealing with mistakes that are made
If the off-payroll rules aren’t applied correctly, responsibility for paying the tax and NICs due stays with whoever failed to play their part. For example, if a contractor does not issue an SDS when required, HMRC can pursue them for the tax due. If an agency fails to deduct tax from payments to a PSC despite receiving an SDS saying the rules apply, they will be liable for the tax due. If HMRC can’t recover tax from an agency they can, in certain circumstances, still pursue the contractor for the money owed instead. It’s therefore important for contractors to make sure they carry out appropriate due diligence on any agencies in their labour supply chain.

Finally, even if all the rules are followed, there is always the chance HMRC could challenge a conclusion that off-payroll working does not apply. If this happens, it will seek to collect the tax and NICs that should have been deducted from payments to the PSC and will inform the floorlayer and PSC that they may be entitled to a refund of other taxes already paid.

However, this is all set to change from April 2024 when new rules will state that any tax paid by the PSC and floorlayer can be offset against the payroll taxes HMRC seek from the contractor. This will leave the floorlayer and PSC unable to claim a refund.

More information
Despite off-payroll working and IR35 being with us for some time, they continue to be a common source of misunderstanding.

HMRC publishes a range of guidance tailored to different parties, all of which can be accessed from GOV.UK, under Understanding off-payroll working (IR35). It’s worth floorlayers and contractors working through this to ensure they understand their responsibilities.
Emma Rawson is a technical officer at the ATT, a professional body for those providing UK tax compliance services.

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