Understanding Off-Payroll Working and IR35 Compliance

If you’re running a business and hiring workers, it’s crucial to understand the different types of employment and how they’re handled by HMRC. This article will explore the concept of off-payroll working, clarify the differences between inside IR35 and outside IR35, and guide you on how to keep your business compliant with tax regulations. We’ll also explain how the right payroll tools can help you avoid errors, maintain happy employees, and manage your tax responsibilities effectively.

What is Off-Payroll Working?

Off-payroll working refers to a set of tax regulations in the UK designed to prevent workers from avoiding tax through intermediaries, such as Personal Services Companies (PSCs) or limited companies. It’s commonly associated with IR35, which requires businesses to assess whether contractors should be taxed like employees. If they should, businesses must ensure the proper taxes are paid.

Defining Off-Payroll Workers

An off-payroll worker is typically a contractor or freelancer who works through an intermediary (like a PSC or limited company) rather than being directly employed by the hiring company. These workers are often brought on for specific tasks or projects and are not salaried employees.

For example, a web designer might be hired by a marketing company to build a website. The designer provides their services to the marketing company and invoices them, rather than being directly employed by the client.

The Role of IR35: What It Is and When It Applies

IR35 is a piece of UK legislation aimed at tackling tax avoidance. It ensures that individuals working in a way that resembles an employment relationship (but through an intermediary) are taxed appropriately, similar to salaried employees. The legislation ensures businesses are not avoiding PAYE tax obligations and ensures that contractors pay the correct amount of tax, compared to regular employees.

The rules can be challenging to apply, and many businesses, especially SMBs, need to be aware of them when engaging third-party contractors. If a self-employed person works directly with a client but operates via a PSC, they may be considered as working “off-payroll.”

Public vs Private Sector: Who’s Responsible?

IR35 legislation saw changes in April 2017, where public sector companies took on the responsibility of determining a worker’s IR35 status. In 2021, this responsibility extended to medium and large private sector businesses as well.

While the responsibility for determining IR35 status rests with the business hiring the contractor, self-employed individuals should also understand the differences between off-payroll working and genuine contracting and be aware of their tax implications. For example, a freelancer working full-time through an off-payroll (inside IR35) contract might end up paying more tax than if they were directly employed.

Inside IR35 vs Outside IR35

The key difference between inside IR35 and outside IR35 comes down to the working relationship. Here’s a breakdown:

• Inside IR35: A contractor working inside IR35 behaves like an employee, working full-time hours for one client. In this case, the company or agency that hires the worker is responsible for deducting income tax and National Insurance Contributions (NICs).
• Outside IR35: A contractor working outside IR35 operates as a self-employed individual, working for multiple clients through an intermediary. They are responsible for managing their own tax affairs and paying the appropriate taxes directly to HMRC.

The Government’s Check Employment Status for Tax (CEST) tool can be helpful for determining if a worker should be classified as employed or self-employed.

Who Determines Employment Status?

In the public sector, the responsibility for determining IR35 status lies with the client (the business hiring the contractor). In the private sector, medium and large businesses now share this responsibility. For small businesses, the contractor is still responsible for determining their own employment status.

Regardless of who determines status, the responsibility for paying taxes and NICs depends on whether the contract is inside or outside IR35. If it’s inside IR35, the client must deduct the appropriate taxes, whereas the contractor is responsible if it’s outside IR35.

Penalties for Incorrect IR35 Status

Incorrect IR35 classification can result in serious penalties for both contractors and employers:

• Contractors:
  • If unaware of incorrect status, contractors may face a penalty of 30% of unpaid taxes.
  • If they knowingly avoid taxes by operating as self-employed when they should be inside IR35, they may face a 70% penalty.
• Employers:
  • Initially, employers are not fined for accidental IR35 errors (until April 2022).
  • However, employers intentionally flouting the rules may face legal action from HMRC and be required to pay any NICs they avoided.

Ensuring Off-Payroll and IR35 Compliance

The key takeaway is that off-payroll working is legal, as long as it’s accurately reported to HMRC, with the correct tax and NIC deductions made. However, the complexity of the rules means businesses can sometimes make genuine mistakes, which could lead to hefty fines.

Alternatively, if you’d prefer to leave it to the experts, we can handle all compliance tasks, ensuring you remain on the right side of the law while keeping your employees happy.