This note adds to and updates an earlier Technical Note published at Autumn Statement 2016. It is intended to help agents and others providing advice to contractors who carry out work for a public authority client whilst working through an intermediary (normally their own company) or a Managed Service Company (MSC). The main focus of the note is the implications for Personal Service Companies (PSCs) but the same rules will generally apply where the intermediary is an individual, or a partnership.
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 the PSC, or other intermediary that they work through.
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. The scope of the measure also extends to certain MSCs.
2. When the new rules come into force
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.
Finance Bill 2017 will bring forward legislation, which, subject to Parliamentary approval and Royal assent will take effect from 6 April 2017. That legislation will amend the current intermediaries legislation IR35 (intermediaries legislation): find out if it applies. in Chapter 8 Part 2 Income Taxes (Earnings and Pensions) Act 2003 as it applies when a worker engaged through an intermediary provides their services to a public authority client. The national insurance provisions are in the Social Security Contributions (Intermediaries) Regulations 2000 (SI 2000 No 727). The new legislation will insert a new Chapter 10 into Part 2 ITEPA 2003 “Off-payroll working in the public sector.” The Social Security Contributions (Intermediaries) Regulations 2000 will be amended to mirror the tax changes.
“Off-payroll working in the public sector” moves the responsibility for deciding if the off-payroll rules for engagements in the public sector apply from an 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 HM Revenue and Customs (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 is likely to start before 6 April 2017 so that authorities are ready.
Where a person is assessed as being within the new rules, the public authority agencies and third parties paying the fee for the services of the worker must operate tax, NICs and operate the Apprenticeship Levy. Tax and NICs will be deducted at source from the payments they make to the worker’s company.
The new rules will not apply where:
- the worker does not have an intermediary such as a personal service company within Chapter 8 Part 2 Income Taxes (Earnings and Pensions) Act 2003 (which includes some MSCs), or
- the agency rules in Chapter 7 Part 2 Income Taxes (Earnings and Pensions) Act 2003 apply and PAYE and NIC is operated by the agency, or
- an agency or umbrella company employs the worker and no intermediary is involved, or
- the worker is a foreign entertainer within the statutory withholding scheme
Where the new rules require tax and NICs to be deducted the Construction Industry Scheme does not apply.
4. Deciding if the new rules apply
The public authority, agency or third party paying the worker is required to decide if the new rules in Chapter 10 Part 2 ITEPA 2003 (and NICs legislation) apply.
5. The change
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.
At present, where the rules in Chapter 8 Part 2 apply, the worker’s intermediary (usually a PSC) is required to assess whether the worker is within the rules and calculate a deemed employment payment at the year end. Tax and NICs are calculated in relation to that deemed employment payment.
Section 54 Chapter 8 Part 2 ITEPA 2003 sets out the method for calculating the deemed employment payment. The Social Security Contributions (Intermediaries) Regulations 2000 calculates an amount of deemed earning on which Class 1 NIC is payable.
Currently, where tax and NICs are due in respect of a deemed employment payment, this is then accounted for by the worker’s company through Real Time Information (RTI) reporting at the tax year end.
Where the new Chapter 10 applies, the whole of Chapter 8 Part 2 will no longer apply in respect of the income the intermediary receives that can be reasonably attributed to a public sector engagement. Instead the fee-payer will deduct tax and primary Class 1 NIC from those payments. The public sector client, agency or third party is treated as if it is the employer of the worker for tax and NIC purposes in respect of these payments and will account for them through RTI.
6. Fee payer deducts the tax and NICs from the fee
The immediate impact on the PSC is that where Chapter 10 applies, the fee-payer will deduct from the fee for the worker’s services, the tax and primary Class 1 NICs due.
7. Secondary Class 1 (employers’) NICs
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.
8. Calculating the tax and NICs
Assume a worker invoices, through their PSC, an amount of £7200 (including VAT) per month to the end client and the off-payroll measures at Chapter 10 apply. No materials and / or expenses are included.
|Deemed Direct Payment (DDP)||£6000.00|
The fee payer will deduct:
|Primary Class 1 NIC||(£413.00)|
The fee payer will also account for Secondary Class 1 NIC £645.13
The payment made by the fee payer to the PSC will therefore be:
|Primary Class 1 NIC||(£413.00)|
The sum 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.
The first step in the Chapter 8 deemed employment payment computation takes the total amount of all payments received by the intermediary in the year in respect of the relevant engagements and reduced that by 5%. As you can see from our example, the new computation in Chapter 10 does not allow this 5% deduction for engagements in the public sector.
9. Personal Service Company is also a managed service company
Under the current rules where Chapter 8 ITEPA and the NICs legislation applies to a company, if that company is also a MSC, as defined in section 61B ITEPA, section 48(2)(aa) ITEPA applies so that the MSC legislation in Chapter 9 Part 2 ITEPA and Chapter 8 does not apply. With effect from 6 April 2017, where a company is a MSC and Chapter 10 Part 2 ITEPA applies, Chapter 9 will not apply.
As demonstrated in our earlier example, where VAT is charged by a PSC in relation to work carried out, the VAT should be computed on the gross invoiced amount not the net fee paid to the PSC by the fee payer.
11. Starter information
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.
12. 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.
13. 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 £7200 the fee payer would physically pay an amount of £5329 to the PSC. This included an amount of VAT (£1200) therefore the corporate accounts would reflect the VAT exclusive amount of £4129 in the calculation of turnover for Corporation Tax purposes.
14. Amount available for the PSC to set against taxes on income drawn from the company
Because the new Chapter 10 Part 2 and NICs legislation subjects the fee to the company to tax and NICs, 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. Chapter 10 Part 2 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, £4129 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.
15. PAYE – Real time reporting
The PSC’s obligations to report employment tax and NICs are largely the same as for deemed employment income under Chapter 8, Part 2 ITEPA 2003. However, any 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.
16. End of year
Because Chapter 10 Part 2, ITEPA 2003 replaces Chapter 8 for public sector contracts, there is no deemed employment payment for the purposes of Chapter 8 except in relation to fees from clients that are outside the new off-payroll rules.
A business with private sector income, within Chapter 8 Part 2 Intermediaries rules still has to work out the deemed employment payment – but excluding the public sector income to the PSC.
17. Corporation Tax and Income Tax
From the example we have used earlier, we find that the PSC received £4129 (exclusive of VAT) for an invoiced amount of £7200. Let us suppose that this amount reflects a monthly income from a 12-month contract in the public sector with no other income;
(Figures exclusive of VAT)
|Invoiced amounts (12 x £6000 - fees)||£72000|
|This reflected as|
|Less statutory tax & NICs deducted by fee-payer (12 x £1871)||(£22452)|
|(the PSC receives relief against employment income, tax and NICs costs)||£22452|
The PSC can pay the worker up to £49548 (the DDP, net of tax / NICs) without any further deduction of tax and NICs. The PSC can retain an amount that is not greater than the sum of the net fees less salary / dividend costs without further liability to tax.
Let us suppose the PSC receives some other income, say £20000 in that same period;
|Invoiced amounts (12 x £6000 - fees + £20000)||£92000|
|This should be reflected in the company as turnover||£69548|
|Less income (12 x £4129 - DDP net of tax/NICS)||(£49548)|
|Less tax & NICs deducted by fee-payer (12 x £1871)|
|(the PSC receives relief for employment income, tax and NIC costs)||£22452|
If the PSC pays the worker more than £49548 (the DDP, net of tax / NICs), further tax and NICs will be chargeable. If the PSC retains an amount that is greater than the sum of the net fees less salary costs, it will incur further tax liability.
Chapter 9, Part 3 section 139 Corporation Tax Act 2009 will be amended to give relief to the business for employment income, tax and NICs costs it incurs (but not so as to give a double deduction).
18.2 Individuals and Partnerships
Chapter 11, Part 2, section 163-164 Income Tax (Trading and Other Income) Act 2015 and Chapter 9, Part 3, section 140 Corporation Tax Act 2009 will similarly be amended to give relief to the business for employment income, tax and NICs costs it incurs (but not so as to give a double deduction).