Karen Thomson, Partner and Head of Payroll Services and People at Armstrong Watson LLP, looks at the issue of employing freelancers

I have a lot of freelancers and contractors on my staff. How do I comply with IR35 tax regulations?

Karen writes: "Changes to off-working payroll rules continue to cause compliance issues and with a third public body hit with a multi-million-pound penalty, businesses need to ensure they comply.

HMRC has issued HM Courts and Tribunal Service with a £12.5m tax bill over mismanagement of IR35 legislation. It is the latest Government body to be hit with a huge tax penalty, after the Department for Works and Pensions and the Home Office were also pulled up and issued with penalties of £87.9m and £33.5m, respectively.

IR35 rules for individuals operating through Personal Service Companies (PSCs) were introduced in 2000 and have been updated a number of times since. The latest reform, in April 2021, requires medium and large businesses to determine the employment status of contractors they hire for tax purposes, whereas this was previously assessed by the contractor.

The legislation is expected to impact around 170,000 individuals working through PSCs, who according to the Government would be deemed employed if engaged directly. It also impacts the end clients as well as recruitment agencies and other intermediaries supplying staff through PSCs.

Companies encompassed by the legislation need to:

• Determine the employment status of a worker and do this for every contract agreed with either an agency or a worker.

• Pass the determination, along with reasons for that to the worker and the person or organisation they contract with.

• Keep accurate and detailed records of the employment status determinations along with the reasons and any fees paid.

• Ensure processes are in place to deal with any disagreements that arise from status determination.

For fee-payers - the lowest party in the labour supply chain - these rules also apply. Fee-payers should be given the worker’s employment status by the client or agency above them in the supply chain and will need to deduct and pay tax and National Insurance contributions to HMRC. In addition, those subject to the apprenticeship levy will need to take this deemed income into account but should note they cannot gain from any NICs paid in respect of the employment allowance.

Small companies who satisfy at least two or more criteria, which are those with less than 50 employees, an annual turnover lower than £10.2m and/or a balance sheet total of less than £5.1m, are exempt. Those deemed small clients in the private sector will not have to decide the employment status of workers but will now need to advise the supply chain they fall outside of the IR35 legislation and ensure their PSC is still accounting for IR35 if directly responsible.

Given that Government departments have been caught out by the changes, it highlights the need for businesses to take professional advice around this area of employment law. It is not as straightforward as one might think and so it is worth ensuring you are not caught out.

One of the reasons for public sector bodies getting into difficulty, I believe, is that the Check Employment Status for Tax (CEST tool) wasn’t fit for purpose when this legislation was implemented.

HMRC has worked with stakeholders to improve the tool but, unfortunately, there are still too many occasions where it doesn’t provide a status determination leaving businesses to rely on other avenues to decide whether off-payroll working rules apply.

Seeking advice if unsure is vital but also gathering the right information is crucial. If what you put into a system isn’t right you will not get the right answer out of it. There are some real complications with this legislation, not least determining who is ultimately responsible for the decision.

It is no good passing the buck to another link in the chain if you are responsible as the penalties for incorrect assessment or application of the rules will fall to the one at the top."

* Karen Thomson has worked in the HR and Payroll industry for more than 30 years. She has headed up the Payroll Services team at Armstrong Watson for the past six years and at the height of the pandemic also took on responsibility for the firm’s HR department.

She is qualified to Masters level and is  appointed as a Chartered Member of the Chartered Institute of Payroll Professionals (CIPP), where she was a former tutor. She sits on a number of government consultation forums representing employer and client views and in 2019 became only the second known Payroll Partner of a UK accountancy firm.