IR35: A complete guide to off-payroll working

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If you have employees, you need to understand what the different types of employment are, and how they are handled by HMRC. In this article, we’re going to explain what off-payroll working is, what the differences are between inside IR35 and IR35, and how to ensure that your business’ HR processes are tax compliant. 

We’ll also explore how having the correct payroll tools can help to mitigate the risk of payroll errors, keeping employees happy while upholding your tax liability.

What is off-payroll working?

Off-payroll working refers to tax regulation in the UK designed to prevent people from avoiding taxes by working through a middleman. Also known as IR35, it requires companies to check whether contractors working for them should be taxed like regular employees and, if so, pay taxes accordingly.

What is an off-payroll worker?

An off-payroll worker is someone who provides services to a company through an intermediary, like a limited company or a personal services company (PSC), instead of being directly employed by the company. They are usually contractors or freelancers hired for specific projects or tasks and aren’t classed as salaried employees. 

For example, a marketing company might hire a freelance web designer to create a website for one of their clients. Although the designer is delivering work for the end client, they would invoice and be paid by the marketing company, which is acting as an intermediary. This is the case whether the end client is aware that the work is being outsourced or not. 

What is IR35 and when does it apply?

IR35 is the UK legislation governing off-payroll working rules. It was brought in to clamp down on tax avoidance, ensuring that businesses aren’t avoiding PAYE, and that sole traders are paying a fair amount of tax compared to salaried employees. It’s seen as being somewhat controversial, as it can be challenging to identify whether someone is truly operating as a business, or whether they are a ‘disguised employee’. 

Most SMBs will need to be aware of IR35, particularly if they employ the services of third-party contractors. Where a self-employed person is working directly for a client, their company is referred to as a Personal Services Company (PSC). While there is no statutory definition of a PSC, the main difference is that, without it, the worker would essentially be employed by the client company.

Public VS Private Sector

IR35 legislation was updated in April 2017, meaning that public sector businesses must take responsibility for determining IR35 status, rather than leaving it down to the consultants and contractors themselves. This was the case for several years, before changes in 2021 saw the same rules applied to the private sector as well, but only for medium, and large businesses. 

While the legal responsibility lies with the business doing the hiring, self-employed contractors should also be aware of the differences between off-payroll working and genuine contracting, as well as the tax implications of the two. For example, a freelancer working full-time hours through an off-payroll (inside IR35) contract will likely pay more tax than if they were employed directly by the client. 

Although the way in which IR35 is applied has changed over the years, the rules determining whether a contract is inside or outside IR35 remain the same. Let’s look at the differences between the two in more detail.

Inside IR35 vs Outside IR35

An off-payroll employee is classed as being inside IR35. They may work 40 hours per week for a single client, working directly with them instead of through an intermediary. The responsibility for deducting income tax and National Insurance contributions (NICs) falls on the entity that pays the worker. This is typically the client or the agency through which the worker is engaged. 

If a person is operating as a genuine contractor, working through an intermediary and/or for a variety of different clients, they are classed as being outside IR35. For these contracts, where the worker is considered genuinely self-employed, the responsibility for paying taxes lies with the worker themselves. They must manage their own tax affairs and pay income tax and NICs directly to HMRC. 

You can use the Government’s Check Employment Status for Tax (CEST) tool to find out whether you, or a worker you’re engaging, should be classed as employed or self-employed for tax purposes.

Who is responsible for employment status

In the public sector, the client (the business hitting the contractor) is responsible for determining whether the contract is inside or outside IR35. Before 2021, private sector businesses didn’t need to determine employment status for contractors. However, an update in legislation now means that medium and large private businesses are now responsible for deciding whether a contract is inside or outside IR35. For small businesses, the responsibility still lies with the contractor. 

Regardless of whose responsibility it is to determine the employment status, the responsibility of who pays tax and NICs depends on whether the contract is inside or outside IR35. If it’s inside, the client will need to deduct tax and NICs from the contractor’s pay, and appropriately report them to HMRC. If it’s outside, the contractor is responsible for their own tax deductions.

Penalties for off-payroll working

In cases where a worker’s IR35 status is incorrect, both parties could face serious consequences. 

For contractors: 

  • Contractors who didn’t know that their employment status was inaccurate could be liable for 30% of their unpaid tax bill. 
  • Contractors who knew that they were within IR35, but operated as if they were self-employed may be liable for 70% of their unpaid tax bill. 

For employers: 

  • In the first year (until April 2022) the employer won’t be fined for accidental IR35 errors.
  • Employers that are wilfully flouting the rules may be taken to a tribunal by HMRC, and could be liable for any NICs they avoided through the deception.

Off-payroll and IR35 compliance

There is nothing wrong with off-payroll contracts, as long as they are accurately determined and reported to HMRC, with appropriate tax deductions and NICs paid. However, this legislation can be confusing, and the penalties could be costly, even if they are down to a genuine mistake. 

To ensure compliance with IR35, as well as the many other different types of employment and tax legislation a business is required to uphold, consider investing in HR software that can automate compliance tasks, saving you time and minimising risk. 

Take a look at our HR payroll software to see how PeopleHR can support your compliance needs or, if you’d rather leave it entirely in the hands of the experts, explore our payroll outsourcing services. 

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Jake Fields
By Jake Fields New Business Sales Representative

Jake Fields is a New Business Sales Representative at Access PeopleHR. With a diverse background spanning customer service, training, and sales, he is a seasoned professional in all things HR software. Jake's global training experience has cultivated strong client relationships across a range of industries. A true people person at heart, his mission is to provide tailored solutions and support individuals throughout their HR journey.