TAXguide 15/21 Off-payroll working: Are you a 'small' private sector client?

Guidance on how to determine the size of a private sector client that uses the services of a contractor provided through an intermediary such as a personal service company.

Under the off-payroll working (OPW) rules effective from 6 April 2021, where a contractor provides services through a personal services company (PSC) to a non-small (ie large or medium sized) private sector client, the client is responsible for determining whether the contractor is a deemed employee for tax purposes, as has been the case since 6 April 2017 where the client is in the public sector. If the client determines that the contractor is a deemed employee, PAYE income tax and NIC needs to be accounted for, normally by the entity in the labour chain with whom the PSC has contracted.

Where the contractor provides services through a PSC to a small private sector client, then the IR35 rules that have been in force since 6 April 2000 apply, under which the contractor needs to determine whether they are a deemed employee of the client and, if they are, account for PAYE income tax and NIC through their PSC.
The rules for determining small for OPW are in s60A-s60H ITEPA 2003 (introduced by Finance Act 2020) which are based on those in Companies Act 2006.

Introduction

Rules from 6 April 2021 modified and extended into the private sector the regime for off-payroll working (OPW) formerly applicable only to the public sector.

One of the changes is that private sector clients of contractors who work via intermediaries such as a personal service company (PSC) need to determine whether:

• they (the client) are ‘small’ and therefore outside the new regime, in which case the IR35 rules in Chapter 8 ITEPA 2003 that have been in force since 6 April 2000 will continue to apply, or
• they (the client) are not small, in which case the April 2017 OPW rules in Chapter 10 ITEPA 2003, as amended from April 2021, apply.

Where the client is small, the contractor’s PSC will continue to be responsible for determining the deemed employment status of its contractor and, if it determines that the contractor is a deemed employee, inter alia accounting for PAYE on, broadly speaking, 95% of the fee charged to the client.

Where the client is not small, the client will be responsible for determining the deemed employment status of each of their contractors who work via intermediaries such as PSCs and, in respect of those contractors who are deemed employees, for ensuring inter alia that PAYE is accounted for on the fees paid to those contractors’ PSCs, normally by the entity with whom the PSC has contracted, known as the fee payer.

The OPW test for ‘small’ is based on the Companies Act rules modified, in broad terms, to:

• make it less likely that the client is small where it is a member of a group of companies or has connected parties, such as joint venture partners, and
• take account of clients that are not companies.

The legislation is in ss60A-60H ITEPA 2003 and, for national insurance contributions (NIC), reg 5A, Social Security (Intermediaries) Regulations 2000 (SI 2000/727) and reg 5A, Social Security Contributions (Intermediaries) (Northern Ireland) Regulations 2000 (SI 2000/728).

The relevant Companies Acts provisions are in ss381-384 Companies Act 2006.

HMRC’s guidance is in its Employment Status Manual ESM10006-ESM10009.

For ICAEW guidance on IR35 and OPW generally visit our IR35/OPW web hub.

For how to work out eligibility for Companies Act purposes, see ICAEW Financial Reporting Faculty guidance Small companies regime – are you eligible?.

How to determine 'small'

For OPW, a client is small or not small for a tax year. So the test has to be undertaken each year.

Size is relevant only for clients, not for other entities in the labour chain, for example, agencies.

When considering small for OPW there are three types of entity:

• ‘corporate entities’, which includes companies and ‘relevant undertakings’, ie, limited liability partnerships, overseas companies and unregistered companies, and
• ‘non-corporate entities’, which comprise:
  - ‘other undertakings’, ie, non-corporate entities with a financial year end, and
  - ‘other persons’, eg, sole traders.

A client that has no UK connection, ie is not UK resident nor has a permanent establishment in the UK, is outside the OPW rules so does not have to consider whether it is small. As the overseas client does not fall within the OPW rules, the April 2000 IR35 rules apply. In such cases, the contractor via their personal service company must determine under the IR35 rules whether the contractor is a deemed employee of the client and account for PAYE on fees if appropriate.

However, non-UK entities are taken into account when assessing whether a client that is part of the same group is small.

The period of accounts against which 'small' is measured

Corporate entities

For corporate entities, the ‘small’ criteria are assessed against the period covered by the accounts for the latest period for which the deadline for filing those accounts at Companies’ House ended before the beginning of the tax year (referred to below as the current financial period).

For example, tax year 2021/22. A private company’s financial year ended on 31 March 2020. The deadline for filing those accounts was 31 December 2020. This filing deadline was the latest to expire prior to 6 April 2021 so the year ended 31 March 2020 is the period to be taken into consideration when testing whether the company is small in 2021/22.

Non-corporate entities

For non-corporate entities with a financial year, known as ‘other undertakings’ in the legislation, the relevant period for determining turnover is the one ending at least nine months before the beginning of the tax year concerned.

For example, a non-corporate entity has a financial year ended 30 June. Nine months prior to the start of the 2021/22 tax year is 5 July 2020. As the entity has a financial year ended prior to this date it uses the period 1 July 2019 to 30 June 2020. This will also apply when considering the connected persons rules.

Non-corporate entities without a financial year, known as ‘other persons’ in the legislation, for example individuals performing a trade, should determine their turnover for the calendar year ending before the tax year concerned.

Four steps to determine 'small'

There are four steps to determine whether a company qualifies as small under the Companies Acts. The key steps are:

1. Is the company ineligible owing to the nature of its business?
2. Is the company a member of an ineligible group?
3. If the company is a parent company, does the group headed by it qualify as a small group?
4. Does the company meet the size criteria?

Under the OPW rules, Step 3 is amended because, instead of considering sub-groups in isolation, it is necessary to consider the worldwide group, and the definition of group is wider. Thus, the key steps will be:

1. Is the client ineligible owing to the nature of its business?
2. Is the client a member of an ineligible group?
3. If the client is a member of a group as extended for OPW, does the extended group headed by the ultimate parent company qualify as a small group?
4. Does the client meet the size criteria?

A non-corporate entity has only to consider one year when determining whether it is small.

Step 1: Is the client ineligible owing to the nature of its business?

An entity will be ineligible to be small if at any point in the period to which its accounts relate it was a public company (plc) even if unquoted or privately held, or engaged in certain activities, including insurance, banking, finance or pensions.

In more detail the ineligible categories are:

• A public company (plc) (even if unquoted or privately held)
• An authorised insurance company
• A banking company
• An e-money issuer
• A markets in financial instruments Directive (MiFiD) investment firm
• An undertaking for the collective investment in transferable securities (UCITS) management company
• A company that carries on insurance market activity
• A scheme funder of a master trust scheme within the meanings given by s391(1) Pensions Schemes Act 2017.

Step 2: Is the client a member of an ineligible group?

The definition of ‘group’ is extended for OPW as follows:

• The entire group, including any parent companies and fellow subsidiaries, whether UK or overseas, needs to be considered.
• The group rules apply to overseas companies, limited liability partnerships and unregistered companies which are part of a group.
• Where the client is owed as a joint venture, then the joint venture undertakings are to be treated as being in a group headed by the client.
• Where a client is connected to or owned by other entities, a similar rule applies to extend the definition of a group for OPW purposes.

A client will be ineligible to be small if it is a member of an ineligible group (as extended for OPW) at any time during the period to which the accounts relate. An ‘ineligible group’ is one that has as any of its members a traded company, or has members engaged in certain activities, including insurance, banking, finance or pensions.
In more detail the ineligible categories are:

• A traded company
• A body corporate other than a company under CA 2006 (eg, a company incorporated overseas) whose shares are admitted to trading on a UK regulated market (Note: for accounting periods beginning before 1 January 2021 substitute ‘regulated market in an EEA state’ for ‘UK regulated market’.)
•  A person other than a small company who has permission under Part 4A Financial Services & Markets Act 2000 to carry on a regulated activity
• An e-market issuer
• A person who carries on insurance market activity
• A scheme funder of a master trust scheme within the meanings given by s391(1) Pensions Schemes Act 2017
• A small company (a company that qualified as small by application of the size limits in relation to its last financial year ending on or before the end of the year to which the accounts relate) that is:
  - An authorised insurance company
  - A banking company
  - A MiFiD investment firm
  - A UCITS management company.

Step 3: if the client is a member of a group, as extended for OPW as described in Step 2, does the group headed by the ultimate parent company qualify as a small group?

If the client is not a member of a group as extended for OPW, skip this step and go to Step 4.

Corporate entities

A group is small if it meets two out the following three conditions (using aggregated figures from the whole group):

• Annual turnover: not more than £12.2 gross or £10.2m net including that of persons connected with the entity which (to avoid double counting) are not members of a group of which the entity is a member (s60G ITEPA 2003, s718 ITEPA 2003 and s998 ITA 2007) (adjusted pro-rata for financial periods not equal to a year);
• Balance sheet total: not more than £6.1m gross or £5.1m net (the balance sheet total is the aggregate of the assets shown in the group’s balance sheet);
• Average number of employees: not more than 50 (this is the sum of the number of individuals employed under contracts of service in each month divided by the number of months in the financial period to which the accounts relate). Ignore deemed employees.

‘Gross’ means before consolidation adjustments and set-offs; ‘net’ means after such adjustments. Any combination of gross and net figures may be met.
It is necessary to consider the above results in consecutive years (see example below). Thus, a group qualifies as small if it meets two out of the following three conditions:

• It meets the size limits (balance sheet, turnover and employee numbers) in the current financial period,
• It met these size limits in the preceding financial period,
• It qualified as a small group in the preceding financial period.

If this is the group’s first financial year, the group needs only to meet the size limits in that year.

Non-corporate entities

For non-corporate entities it is necessary to consider only turnover including that of persons connected with the entity in the financial period ending before the start of the tax year or the calendar year, as applicable. Thus, the consecutive years two out of three conditions rule which applies to corporates does not apply.

Step 4: does the client qualify as small because it meets the size criteria?

Apply the criteria below to the client entity alone.

Corporate entities

A corporate entity client is small if it meets two out of the following conditions:

• Annual turnover: not more than £10.2m including that of connected persons (adjusted pro-rata for financial periods not equal to a year);
• Balance sheet total: not more than £5.1m;
• Average number of employees: not more than 50 (this is the sum of the number of individuals employed under contracts of service in each month divided by the number of months in the entity’s financial period). Ignore deemed employees.

It is necessary to consider the above results in consecutive years. Thus, an entity qualifies as small if it meets two out of the following three conditions:

• It meets the size limits (balance sheet, turnover and employee numbers) in the current financial period,
• It met these size limits in the preceding financial period,
• It qualified as small in the preceding financial period.

If this is the entity’s first year, the entity needs only to meet the size limits in that year.

See below under Examples for how the consecutive years test works with a case study.

Non-corporate entities

For non-corporate entities it is necessary to consider only turnover but including that of connected persons in the financial period ending before the start of the tax year or the calendar year, as applicable. Thus, the consecutive years two out of three conditions rule which applies to corporates does not apply.

Examples

Consecutive year two out of three conditions test (see Steps 3 and 4 above)

As for financial reporting purposes, it is necessary for corporate entities to consider the results in consecutive years. As noted above, a company qualifies as small if it meets two out of the following three conditions:

• it meets the small size limits in the current financial year,
• it met these small size limits in the preceding financial year,
• it qualified as a small company in the preceding financial year.

^{* Assuming first year of trading or was small in the previous year.}

Case study: Pear Ltd

Pear Ltd has an accounts year end of 31 October. It contracts from time to time with Pete's PSC for Pete to undertake various projects.

Pear Ltd’s results for many years up to the year ended 31 October 2019 showed Pear Ltd to be small.

The filing date for Pear Ltd’s accounts for the year ended 31 October 2019 was 31 July 2020. The next tax year beginning after this filing date is 2021/22. Because Pear Ltd is small, for payments made in 2021/22 for work under off-payroll working contracts it will be Pete's/Pete’s PSC’s responsibility to decide whether or not IR35 applies.

Following an upturn in the fortunes of Pear Ltd, it breached two of the small company size thresholds and fell into the medium size bracket for turnover and employee headcount for its year ended 31 October 2020.

Because it must consider two consecutive years to determine size, Pear Ltd remained small for the year ended 31 October 2020.

The filing date for the accounts for the period ending 31 October 2020 is 31 July 2021. The tax year beginning after this filing date is 2022/23. Because Pear Ltd is small, for payments made in 2022/23 for work under off-payroll contracts it will be Pete's/Pete’s PSC’s responsibility to decide whether or not IR35 applies.

If Pear Ltd carries on its successful trading streak for the year ended 31 October 2021 and again satisfies at least two out of three size criteria for medium, it will under the consecutive year test be considered a medium company for its year ended 31 October 2021.

The filing date for the accounts for the period ending 31 October 2021 will be 31 July 2022. The next tax year beginning after this filing date will be 2023/24. Therefore, for payments made in 2023/24 for off-payroll working contracts, Pear Ltd must determine Pete’s employment status and begin to issue status determination statements (SDS) under the OPW rules, and Pete/Pete’s PSC will no longer be responsible under the IR35 rules for making employment status decisions on his PSC’s contract with Pear Ltd.