April 2020 sees the start of the off payroll working rules, effectively rolling out the rules introduced in 2017 in the public sector to most businesses engaging contractors through Personal Service Companies.

This is a major change and will require a lot of planning for both contractors and Engagers.

Engagers that are “small” for Companies Act purposes are not required to follow the new rules, and for unincorporated businesses the test is simply turnover in the last set of accounts preceding the tax year.

All start-up businesses are small for this purpose for their first year, irrespective of their actual size.

For Engagers who have to follow the new rules it will mean assessing the employment status of the individuals actually doing the work (that is, frequently, the director of the PSC). HMRC is revamping the online status tool CEST to support businesses with this, but it remains, as always, a complex question.

Once the status determination is complete the Engager will issue a Status Determination (SDS) to contractors who are regarded as employed. If the Engager is paying the PSC directly, they will then need to gather the information needed to put the worker on the payroll and must deduct PAYE and operate NIC (including paying over the employer element) from 6 April 2020.

Decisions will have to be made about whether the invoices are still processed through the purchases system or whether they will be passed directly to payroll.

Similarly, a decision will be needed on whether the payment will be made through the normal purchase ledger payments function, or whether payroll will make the payments. This will, of course impact on the operation of RTI under which the figures must be reported “on or before” payment is made.

Where the PSC is paid by another party – often an agency – the Engager must pass a copy of the SDS to the agency it deals with. Where there are multiple agencies in a chain, the SDS is passed along the line until it reaches the body which actually pays the PSC, known as the Payer in the legislation.

The Payer then has the responsibility for the administration of the payroll deductions – although they will probably invoice the Employer NIC amount over to the Engager.

For the contractors affected by this there is a difficult financial hurdle to negotiate. They will see their tax burden rise considerably under PAYE and NIC and if they may have entered into financial commitments that they can no longer meet, and life could be very tough for them next year.

In reality, if all of their work is affected by the new rules there is little point in still having the limited company – it will cost money to get accounts and CT600s done, but this cost will have to come out of post-tax salary.

However, for some Engagers the issue of employment rights will mean that they are unwilling to deal with these contractors without the shelter of a limited company, so it is a real no-win outcome.

The example below illustrates the financial impact. The contractor will be declaring the income from off-payroll working on his tax return as employment income, naming the payer as his employer. The income will not be taxable in the company, nor will it be taxable when distributed to the director.

Example net pay difference: contractor affected by off payroll working

2019/20

Gross income (billings)                             £ 50,000

Overheads                                                    (1,500)

Salary                                                            (8,600)

Taxable profit                                             £ 39,900

Corporations tax (19%)                                 (7,581)

Net profit = taken as dividend                   £  32,319

 

Total income (salary + dividend)               £  40,919

Personal allowance                                     (12,500)

Taxable                                                     £  28,419

 

Tax at 0% on £2,000                                             0

Tax at 7.5% on £26,419                                  1,981

 

Net income                                                 £38,938

 

2020/21

Gross income (billings)                                £50,000

Personal allowance                                      (12,500)

Taxable                                                        £37,500

 

Tax at 20% on £37,500                                  ( 7,500)

NIC at 12% on £41,368                                   (4,964)

Net pay                                                        £37,536

Overheads                                                     (1,500)       

 

Net income                                                  £36,036

 

This is a reduction of £2,902 in take home pay. If the Engager reduces the rate of pay to reflect the Employer NIC they have suffered (as has been common since 2017) the gross income becomes £44,983 (giving a gross cost to the engager of £50,000). This results in net income of £32,624, a reduction of £6,314.