The changes to the employment conditions for contractors and off-payroll workers has been looming for a while now. After being delayed due to the COVID-19 pandemic, the IR35 reform is set to come into force in April 2021.
This will affect any medium-large sized business that hires contractors or freelance workers (small businesses are exempt). The goal of the reform is to define what a contractor is in terms of employment – and how they differ from actual employees – ensuring all are taxed accordingly. The onus falls on the company rather than the contractor to determine their employee status and ensure they are paid accordingly.
In order to stay compliant and avoid paying tax and contributions in arrears, it is essential that employers are fully prepared for this change and aware of the implications. We have put together the following tips to help you understand what steps you need to take to ensure that your business’s payroll is ready for IR35.
READ MORE: You can read more about the IR35 implications for payroll here.
1. Conduct an audit
Your first port of call when determining what steps your business needs to take to prepare for IR35 is to conduct a thorough audit of your employees, clients and contractors to determine who falls inside and outside of the new rules.
If you rely on a high volume of contractors then now is a good time to identify which areas of the business use these, how essential they are and what they contribute to the business. This will also affect contractors employed through a third party such as an agency.
2. Determine the employment status
After you have completed an audit of your employees, contractors and clients, you’ll need to determine whether your employees fall inside or outside of the new rules. To do this you will need to check their employment status – this can be done using the HMRC (CEST) tool.
It’s important to understand whether the contractors operate as sole traders, limited companies or under an umbrella company, as this will be part of whether they fall inside or outside of the rules. Other factors include their hours of work and whether they are project based.
This process needs to be done on a case-by-case basis to ensure that everyone is paying the correct amount of tax. HMRC states that ‘reasonable care’ must be taken when conducting this assessment so it’s advisable not to do a blanket assessment.
After you have completed this you will need to produce a status determination statement (SDS).
3. Communicate with employees and contractors
Once you have completed the assessment you must share the status determination and the reasons for the determination with the employee, contractor/off-payroll worker and if applicable the party with which the individual contracts.
It’s good practice to keep your contractors informed every step of the way so they will understand that you are taking every care – and that it doesn’t come as a surprise if their employment status suddenly changes.
Be prepared to answer questions and gather the information you might need in advance. If the contractor falls inside IR35 then they will likely need to switch to PAYE in order to continue working with your company – this change will mean they will have plenty of questions, so ensuring all parties are informed will make things easier. Being open and transparent will stand you in good stead for the future relationship.
In the event that the contractor disagrees with the IR35 classification then they will need to contact you with their reasons, after which you must respond within 45 days. Continued communication will be key to resolving this.
4. Be prepared for higher costs
There will be additional costs for the business, as contractors look to increase their rates to compensate for their tax and national insurance being deducted by employers. You will need to factor these costs in.
5. Set up your payroll
Once you have taken these steps you’ll need to ensure that your payroll and HR systems are fully set up to account for the changes.
Contractors becoming PAYE will need to be set up on the system and your payroll cycles set up accordingly; we recommend separating deemed employees from direct employees for reporting and contractual purposes. Your payroll software should have been updated to identify the off-payroll workers, therefore HMRC will no longer issue prompts for student loan deductions.
If you have contractors who operate through an agency then it will be the agency’s responsibility to deduct tax and communicate with HMRC. You can read our more payroll considerations for IR35 here.