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Following recent tax reforms, there are now two coexisting sets of tax rules for independent contractors (aka “off-payroll workers”) who provide services to a client through an intermediary such as a personal service company, an umbrella company, a partnership or an individual. In this article, we explain the main differences between IR35 and its younger counterpart, the Off-payroll Tax.
What does the law say?
IR35: Named after the Inland Revenue (former UK tax authority) press release which announced it, IR35 refers to chapter 10 the Income Tax (Earnings and Pensions) Act 2003 and the Social Security Contributions (Intermediaries) Regulations 2000. Under this legislation, contractors have to pay income tax and National Insurance contributions as if they were employees. The aim is to tackle tax avoidance by workers who inaccurately claim to be self-employed.
Off-payroll Tax: Introduced by Schedule 1 paragraph 9 to the Finance Act 2017, it inserted chapter 10 to ITEPA 2003. Responding to bitter criticism over the application of IR35, the Off-payroll Tax changed the rules for calculating and paying the income tax and National Insurance contributions owed by contractors who are deemed to have employee status by ITEPA 2003.
Who does it apply to?
IR35: Until April 2017, IR35 applied to all independent contractors in the UK. However, it presently only applies to contractors whose end client (aka “engager” or “hirer”) is a small company in the private sector. A small company is defined by the Companies Act 2006 as a business which meets at least two of the following conditions: a turnover of no more than £10.2 million, a balance sheet total of no more than £5.1 million, and no more than 50 employees.
Off-payroll Tax: In April 2017, Off-payroll Tax was introduced by HMRC for contractors who were hired by public authorities. In April 2021, Off-payroll Tax was extended to apply to medium and large sized businesses in the private sector, as well as charities.
How is it calculated?
IR35: When IR35 applies, you need to calculate something called the “deemed payment”. This can be done using an IR35 calculator or manually using the following guidance. The deemed payment is seen as the contractor’s gross cost of hire (with a 5% expenses allowance deducted), and tax and National Insurance contributions are paid from it. It effectively results in contractors paying taxes which should have been paid by their clients.
Off-payroll Tax: The fees paid to the contractor are called the “deemed direct payment” and are basically treated like the contractor’s salary. It is calculated by subtracting expenses incurred by the limited company that would be claimable if the contractor was employed and any costs of materials from the fees paid to the contractor (excluding VAT). The result is treated as salary, so is then subject to income tax and employment taxes via Pay As You Earn (PAYE). The fee-payer (either end client or agency) is thus the one to pay employer’s National Insurance, and they do this on top of the fees paid to the contractor.
Who is responsible for working out employment status?
IR35: For those whom IR35 still applies to, it is the contractor who is responsible for working out whether or not they fall within the scope of IR35. The government offers the following tool, Check Employment Status for Tax (CEST), to help individuals assess their employment status from HMRC’s perspective.
Off-payroll Tax: The client is responsible for working out the contractor’s employment status. Private sector clients have a duty to provide contractors with a “Status Determination Statement” (SDS) at the start of every engagement. This document details the reasons for having reached the conclusion they reached, and the contractor can challenge it if they disagree with the status they have been deemed to have. The Off-Payroll Tax has shifted responsibility for compliance with the tax rules away from the contractor, although it is advisable for the contractor to remain aware as this affects them.
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The opinions on this page are for general information purposes only and do not constitute legal advice on which you should rely.
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