HMRC has published a document answering the many questions that accountants were asking for clarification surrounding the practical accounting of the new P35 legislation.
The off-payroll rules (often known as IR35, or ‘the intermediaries legislation’), ensure that individuals who work through their own company pay employment taxes and national insurance contributions (NICs) in a similar way to employees, where they would be employed were it not for their limited company acting as an intermediary.
The government announced at Budget 2016 that, from April 2017, where the public sector engages an off-payroll worker through their own limited company, that body (or the recruiting agency if the public sector body engages through one) will become responsible for determining whether the rules should apply, and for paying the right tax and NICs.
When do these rules come into effect?
The new rules operate in respect of payments made on or after 6 April 2017. This means that they are relevant to contracts entered into before 6 April 2017 but where the payment for the work is made after 6 April 2017. This is important to note for works undertaken in March.
Making the decision as to whether this applies
The responsibility for deciding if the off-payroll rules for engagements in the public sector apply moves from the individual worker’s intermediary to the public authority, agency, or third party paying the intermediary. The measure makes that public authority, agency, or third party responsible for deducting and paying the associated employment taxes and NICs to HMRC.
The result will be that public authorities, agencies and third parties will be assessing whether the workers they engage through this type of structure are inside or outside the key test in the IR35 legislation: whether, but for the existence of the service company, the way the worker carries out work for the client means they would have been an employee. This process has started and most agencies have taken a risk adverse approach. You can use the toolkit yourself to see if these new rules do apply to your contract in your opinion too.
Link to toolkit: https://www.tax.service.gov.uk/check-employment-status-for-tax/setup
Broadly speaking, the intention behind the intermediaries rules is to ensure that where the worker works for a client in a way that would have been an employment but for the existence of the intermediary, that tax and NICs is deducted from the worker’s income at a similar rate as a comparable employee.
Fee payer deducts the tax and NICs from the fee
The immediate impact is that where the new IR35 rules apply, the fee-payer (usually an agency) will deduct from the fee for the worker’s services, the tax and primary Class 1 NICs due.
Because the fee payer has a liability to pay secondary Class 1 NICs, they are likely to wish to renegotiate the fee with the intermediary to reduce the rate for the job. They cannot lawfully deduct the secondary NICs from a fee that has been agreed, but could, depending on the contractual terms, negotiate a lower fee.
Calculating the tax and NICs – example
Assume a worker invoices, through their PSC, an amount of £7200 (including VAT) per month to the end client. No materials and/or expenses are included.
|Sales (Net of VAT)||£6,000|
|VAT at 20%||£1,200|
|PAYE to be deducted||£1,458|
|Class 1 NIC to be deducted||£413|
|Net fee payable||£4,129|
|VAT at 20%||£1,200|
|Total payment received||£5,329|
The sums deducted from the fee is paid over to HMRC. The fee payer sends the relevant information to HMRC through its PAYE reporting processes. There is no requirement for the worker to be given a payslip but they will be given a P60 or form P45!
When the worker starts, or when changes in circumstances mean that the rules should be applied, the fee payer will need to send a starter declaration to HMRC.
They will ask the worker to sign a Starter declaration C for workers engaged through their PSC. The worker will have a primary employment with their own company so the services they provide are treated as a secondary employment.
Starter declaration C means that they will operate tax code BR and deduct tax at basic rate until HMRC issues a code.
There is no requirement for the worker to provide a P45 from a previous employment.
Worker’s Self-Assessment Tax Return
The worker should reflect the engagement with the fee payer as an employment on the employment pages of their Self-Assessment and the amount of the deemed direct earnings on which tax and NICs has been operated as employment income. The employer identified for the deemed employment is the fee-payer.
It would seem that no personal allowance will be used and as such if all contracts are entered into using these new rules in a fiscal year the worker will be entitled to a personal tax rebate of around £2,300 each year.
Accounts of the intermediary PSC
The accounts of the PSC should reflect the amount that the company receives. That is the net amount after the tax and NICs have been deducted.
From the example above we established that from an invoiced amount of £7,200 the fee payer would physically pay an amount of £5,329 to the PSC. This included an amount of VAT (£1,200) therefore the corporate accounts would reflect the VAT exclusive amount of £4,129 in the calculation of turnover for Corporation Tax purposes.
Amount available for the PSC to set against taxes on income drawn from the company
The worker would feel that they are double taxed if they pay income tax and NICs on all the monies subsequently taken out of the company as dividends or employment income. The legislation allows the business to set an amount equivalent to the amount on which tax and NICs were paid at source, against the income drawn from the company by the worker.
The PSC pays the worker a salary that would otherwise have attracted tax and NICs. However, the PSC is able to set against that the amount which has already been subjected to PAYE / NICs, £4,129 in our example. The PSC will incur no further PAYE/NICs liability unless the payment to the worker exceeds the level of the net fee received.
PAYE – Real time reporting
An amount of employment income paid that has been subject to deduction of tax and NICs in this way should be recorded on a Full Payment Submission (FPS) as non-taxable income and the amount of gross taxable employment income recorded reduced accordingly.
To report non-taxable income, you should use the FPS data field 58A: Value of payments not subject to tax or NICs in pay period.
Corporation Tax and Income Tax – example for the year
From the example we have used earlier, we find that the PSC received £4,129 (exclusive of VAT) for an invoiced amount of £7,200. Let us suppose that this amount reflects a monthly income from a 12-month contract in the public sector with no other income.
|Invoiced amounts||12 months at £6,000||£72,000|
|Tax and NIC deducted||12 months at £1,871||£22,452|
|Sales for statutory accounts||£49,548|
|PSC receives relief against employment income, tax and NIC costs||£22,452|
The PSC can pay the worker up to £49,548 without any further deduction of tax and NICs and as such no corporation tax is payable since profits will be reduced to nil.
Let us suppose the PSC receives some other income (net of VAT), say £20,000 in that same year:
|Invoiced amounts||12 months at £6,000 plus £20,000||£92,000|
|Tax and NIC deducted||12 months at £1,871||£22,452|
|Sales for statutory accounts||£69,548|
|Directors salary free of tax and NIC per above||£49,548|
|Taxable Profits (if no expenses to deduct)||£20,000|
|Corporation tax at 20%||£4,000|
|Profits available for distribution as a dividend subject to personal tax.||£16,000|