Lindsey Wicks explains the current inequalities when a client makes an incorrect status determination and what the government plans to do to redress the balance.
The off-payroll working rules (or IR35) have been around for over 20 years. They apply where an individual is working like an employee but provide their services through an intermediary such as a personal service company (PSC).
There was a relatively recent shift in the responsibility for determining the status of a contractor. Since 2017 in the public sector and 2021 for medium and large-sized clients in the private and voluntary sectors, the client has been responsible for determining employment status instead of the worker’s intermediary. If the client determines that the off-payroll worker is a deemed employee, the entity that pays the fee for the work to the worker’s PSC (the deemed employer, also known as the ‘fee payer’) must account via PAYE for taxes and national insurance contributions (NIC) and (if applicable) the apprenticeship levy.
But what happens if the client makes an incorrect status decision?
The current position
If, following a compliance check, HMRC determines that the client incorrectly decided that the engagement was outside the off-payroll working rules, the deemed employer must account for the tax and NIC and (if applicable) the apprenticeship levy.
Instead of HMRC taking account of the tax and NIC already borne by the PSC and the worker, the deemed employer must account for the full amount of tax due
However, the PSC will have paid corporation tax on the income from the engagement and the worker will have paid income tax on salary and dividends received from their PSC along with NIC on any salary. The PSC may also have paid class 1 secondary NIC on the salary.
Instead of HMRC taking account of the tax and NIC already borne by the PSC and the worker, the deemed employer must account for the full amount of tax due. To avoid amounts being taxed twice, HMRC will seek to refund the PSC and the worker.
If the deemed employer is unable to enforce any contractual indemnities given by the PSC, this means that the deemed employer bears all the tax burden and the worker bears none of the tax cost.
A client engages a worker to provide services through their PSC for a fee of £40,000. The client assesses the worker as outside the off-payroll working rules and therefore pays the PSC a gross fee of £40,000. The PSC then pays the worker in the most tax-efficient way: a salary up to the class 1 primary NIC threshold (£12,570 in 2023/24) and the remainder as a dividend.
The proposed solution
In its consultation Off-payroll working: calculation of PAYE liability in cases of non-compliance, HMRC proposes a limited set-off against the deemed employer’s liability to deduct income tax and class 1 primary NIC in respect of the worker. No set-off would be available against the deemed employer’s class 1 secondary NIC liability or apprenticeship levy.
The taxes and NIC borne by the worker and their PSC that might be included in a set-off are:
- corporation tax paid by the worker’s PSC on the income from the engagement;
- income tax and class 1 primary NIC paid on any salary paid by the worker’s intermediary from income from the engagement;
- class 2 and class 4 NIC on income from the engagement where the intermediary is a partnership or other individual; and
- income tax on dividends paid to the worker from the PSC paid out of income from the engagement.
The proposed set-off would not extend to class 1 secondary NIC paid by the PSC although the PSC could still claim a refund. In addition, voluntary class 3 NIC paid by the worker and tax and NIC on salary or dividends paid to any other employees, shareholders or directors of the PSC are excluded from any set-off.
While set-off provides for a more equitable solution, there are a number of practical challenges.
By far the greatest challenge is accurately determining the tax paid by the worker and their intermediary in respect of the engagement. Unlike the example in this article, the reality is that they may have multiple revenue streams and tax-deductible expenses. Other complications include the intermediary’s accounting date, other shareholders, other employees and how the profits are extracted (for example, the intermediary may make pension contributions to the worker’s pension fund). The worker may have other income sources including investment income and property income.
While set-off provides for a more equitable solution, there are a number of practical challenges
While the solution may lie in HMRC making an estimate of the amount of tax paid by a worker and their intermediary in respect of the engagement based on historical tax return data, the worker and their intermediary will want sufficient time to check that estimate. For this reason, ICAEW’s Tax Faculty has suggested that the time limit for the worker or their intermediary to appeal against the direction should be 60 days rather than the standard 30-day time limit.
To allow HMRC to facilitate issuing a direction to the correct parties, it may require more information than the client would currently collect where it has assessed an engagement as falling outside the off-payroll working rules. The Tax Faculty asked whether it is envisaged that a requirement will be introduced for workers to provide this data to their clients.
When might this become a reality?
The consultation suggests that the set-off facility might be available from 6 April 2024 and would apply regardless of when the error arose. However, the policy would not apply retrospectively where the deemed employer settles the PAYE liability before that date. The faculty therefore advocates HMRC moving quickly to issuing draft legislation for technical consultation as deemed employers may delay settling liabilities until set-off is available.
Lindsey Wicks, Senior Technical Manager, Tax Policy, ICAEW
- TAXguide 07/23: Making R&D claims – what information must be submitted and when?
- TAXguide 06/23: A basic guide to pillar two
- TAXguide 05/23: Tax relief for pension contributions – recent changes
- TAXguide 04/23: Payroll and rewards update 2023 – Q&A
- TAXguide 03/23: R&D tax relief for accounting periods spanning 1 April 2023