Understanding Pay rates - IR35 Off-Payroll

Until April 2021, when the Government will implement the new IR35 Off-Payroll in the Private Sector legislation (postponed from April 2020) it continues to be the contractor’s responsibility to determine whether they are operating inside (also known as caught by) IR35 or outside IR35, and whether the same tax should be paid as if the contractor was employed by the end client. Should HMRC decide to investigate the true workings of their contract and find the contractor had made the wrong determination then their personal service company is liable for any unpaid taxes.

From 5 April 2021 the responsibility, and therefore any potential tax liabilities, falls with the engager if they are medium or large, (small businesses are exempt, more specifically those where two of the following apply – turnover less than £10.2m, balance sheet less than £5.1m, not more than 50 employees). The company paying your personal service company (generally the agency) will be liable for submitting the Income Tax and National Insurance (both Employer’s and Employees’) that becomes payable if the role is considered inside IR35 (the same deductions that would be made if a contractor deems themselves caught under current legislation). The PSC will receive confirmation from the end client who will have a legal responsibility to provide that opinion, or determination, for the role.

This means that if your end client is medium or large, it will have to undertake an IR35 assessment for each assignment and decide whether you are operating inside or outside IR35.

HOW WILL THIS AFFECT YOU?

The changes apply to those working through a personal service limited company. It will not make any difference to workers using an umbrella company as all income is already taxed as employment income.

WHAT WILL THE EFFECT BE?

If the assignment is deemed outside IR35 then the director/shareholder can continue to extract profits in a combination of salary and dividends.

If the assignment is deemed inside IR35 then ALL of the fees will be subject to income tax and national insurance. Simply put, VAT is paid on the gross amount, the Employer’s NI (essentially the PSC’s NI) is paid over by the agency, along with Employee’s NI and PAYE, and you are paid the net plus the full VAT figure. No more tax (ie corporation tax, dividend tax) is due on this payment and it can be taken straight out of your company. Your pay rate will appear to be lower than if it was outside IR35 with this difference being the Employer’s NI (and Apprenticeship Levy if applicable depending on the size of the agency’s staff and deemed payroll). It is important to stress that the PSC would pay the Employer’s NI under current legislation if deemed inside IR35 (*see table at the end.)

A LITTLE MORE DETAIL:

For example, a contractor caught inside IR35 who is used to earning £300 per day outside IR35, is likely now to be offered a rate of around £260 per day inside IR35 (the difference being the submissions that the agency needs to make to HMRC for Employer’s NI, as well as the apprenticeship levy if it applies – this is no different from paying £300 per day and the PSC submitting the Employer’s NI – it’s just that this now has to be made on the agency’s ‘deemed’ payroll (the contractor is classed as a ‘deemed employee’). From the £260 per day, employment deductions of Employee’s NI and PAYE will be made, before the ‘deemed’ payment is made to the ltd company. (*see table at the end.)

If one simply compares £300 per day to the new payment of £260, less deductions, then clearly there is a significant difference.

But it is not that simple as there are other rules/obligations that need to be considered.

For those INSIDE IR35:

Your company is paid the Deemed Payment (the net payment after deductions made to the contractor’s ltd company):
Once the deemed payment is made to the ltd company, you still need a way of taking that money out of your ltd company This can be done in 2 ways (both ways are tax free and will see no further deductions):

1. Dividends:
If you’re a director of your own company, you might choose to pay yourself a dividend from the company’s profits. You can pay yourself a tax-free dividend up to the total of the deemed direct payment received from contracts in the public sector, where Income Tax and NICs have been deducted at source. You don’t need to declare that dividend on your Self Assessment tax return.

2. Payroll:
You can pay yourself for the work provided to your client through your company’s payroll. As employment taxes have already been paid on the amount your intermediary (your ltd company) receives, you can pay yourself that amount without deducting Income Tax or NICs.

And the icing on the cake:

No Corporation Tax…

When you are calculating your company’s turnover, you should deduct the VAT exclusive amount of the invoice, which is the amount from which Income Tax and NICs were deducted at source. Your company accounts should show this deduction to make sure the amount is not taxed twice.

So to put it simply, the amount paid to you by the agency is yours to take out of your PSC (your ltd company) WITHOUT ANY FURTHER DEDUCTIONS.

For those OUTSIDE IR35

To get your £300 per day out of your ltd company, again you can pay yourself dividends, or a salary (or mixture of both)

Dividends:

The tax advantages between dividends and salary are diminishing but, nevertheless, there is still a slight advantage to dividends. As opposed to the Inside options above, your dividend will be liable to dividend tax, AND corporation tax.

Payroll:

You can take it as salary – but your company will be liable for Employer’s NI (aha, so there’s the difference between the £300 and £260 already gone), then there are the same NI and PAYE deductions taken that were taken for your deemed payment, meaning that if you were to pay yourself purely by means of a salary, your take-home will be the same as if you received the deemed payment from the agency.

SHOULD I USE AN UMBRELLA COMPANY?

And to keep things really simple, using a compliant umbrella company means that the legislation will not apply, you will not have the headache of running a company.

WHICH WILL GIVE ME THE BEST TAKE HOME, UMBRELLA OR PSC?

It could be marginal either way. And not something answered easily. You would need to consider accounting costs, umbrella costs, tax codes, hassle costs, what else you do with your ltd company (ie pension payments etc), etc etc etc. If the only thing you use your PSC for is to pay yourself, then an umbrella may be a simpler option.

It’s worth reminding readers that if a contractor had previously deemed themselves within IR35 (IR35 rules have not changed, but who decides when they apply has), they would have to pay themselves from their Ltd company as an employee on the whole gross amount earned – their PSC would pay Employer’s NI (and submit to HMRC), then deduct Employee’s NI and PAYE from the pay, to come to a net pay amount.).

IN SUMMARY:

*I will finish with a ‘simple’ table to try to illustrate that the difference in the pay rate quoted for a contractor using an umbrella and a contractor using their PSC is purely down to timing of deductions (where IR35 applies):

Please note the figures are for illustrative purposes only