Off-payroll rules reminder: When contractors should (and shouldn’t) be paying Employer NI

Despite the postponement of IR35 changes to April 2021, many contractors have already seen changes to their rates of pay.

A point raised in many negotiations has been Employer National Insurance (NI), with confusion as to who is responsible, or liable, for these payments, not to mention when and where in the supply chain they should be deducted.

The issue stems from a lack of clarity on the rates agreed between contractors and their agencies, or between contractors and their umbrella companies. Coupled with the drafting of the new IR35 rules, this is causing increasing confusion in the market.

Here, exclusively for ContractorUK, Matt Fryer, head of legal services at Brookson Group sets the record straight.

Issue 1 – The rate

Typically contractors are offered two pay rates from their agency. 

The first is commonly called the “PAYE rate” which is the rate paid to the contractor as a gross salary in the event the contractor works directly for the agency. 

The second rate offered is usually referred to as the “limited company rate” which is the rate paid to a limited company which the contractor appoints to contract with the agency to receive and process their pay (this is usually an umbrella company or a PSC). 

The “limited company rate” is higher than the “PAYE rate” as it includes the employer costs which the agency does not have to pay.  

To simplify the example I have provided below, I’ve used Employer NIC and the Apprenticeship Levy at a flat rate of 14% to demonstrate the impact of the employer costs. It is important to note that there may be other associated employer costs, depending on the nature of the contract.

  PAYE rate example Ltd company rate example (if working through umbrella) Ltd company rate example (if working through PSC)
Price per hour paid by client to agency £112 £112 £112
Less agency margin (£12) (£12) (£12)
  £100 £100 £100
Agency “employer costs” (employers NIC and apprenticeship levy) (£14)    
PAYE rate paid by agency to contractor £86    
Limited company rate paid by agency to umbrella or PSC   £100 £100
Umbrella “employer costs” (employers NIC and apprenticeship levy)   (£14)  
Gross wage paid to contractor by umbrella   £86  
Gross amount received into contractor’s limited company (no employer costs – assume outside IR35)     £100

As can be seen in this example, the limited company rate when applied to an umbrella company nets down to the same gross pay as the PAYE rate. It is, however, imperative that the agency and umbrella company are transparent with the candidate regarding this calculation and the umbrella company’s contract of employment covers the way in which employer costs are calculated. 

The role of the Key Information Document

The government is aware of this confusion and have recently introduced the Key Information Document (KID) which all agencies must now issue to candidates (if they are registered from April 6th 2020). This KID should include a calculation similar to the example above to ensure the pay rates are clear and transparent to the candidate. In addition, umbrella companies should be explaining the impact of the employer costs on the take-home pay of their employees at sign-up stage. 

Often a “Pay Illustration” is issued by the umbrella company to ensure total transparency. Unfortunately, some agencies are not yet issuing the KID and some umbrella companies are not transparent in the calculation at the point of contract, which results in a (nasty) surprise for the contractor when they receive their first payment.

You will notice from the above example that the limited company rate provides a favourable result when using a PSC. This is why working in this way is favourable to contractors, as there are no associated employment costs. It is also why IR35 was introduced to ensure that the employer costs are paid where the contractor is working on an assignment which is akin to an employment relationship. This is where the second area of confusion arises.

Issue 2 – The new IR35 rules

Under the existing IR35 rules, if the contractor is assessed as inside IR35 then the employer costs used in the example above (£14) will materialise. The contractor’s PSC will be responsible for paying those costs out of the £100 it has received, making a net £86 available to be paid to the contractor as a gross salary. 

As can be seen, under the existing rules a contractor inside IR35 will receive the same net pay as they would if they were working on the agency payroll or via an umbrella company. It is simply different “employers” who are responsible for making the deductions and paying them over to HMRC.

The new IR35 legislation (set to be implemented on April 6th 2021) includes provisions which require the ‘fee-payer’ (the agency) to pay any associated employer costs for contractors it pays who are working through a PSC which are deemed to be inside IR35. 

The challenge for agencies

The legislation also requires that these employer costs are not paid out of the contract rate agreed with the contractor. So, in the example above, if the PSC was on a contract which was inside IR35 post-April 2021, then the fee-payer must pay the £100 to the PSC. But it must also pay circa £14 of employer costs on top of this directly to HMRC. The agency has only made a margin of £12, so this is not commercially viable. 

The other impact of this rule is that the contractor would receive more pay than they would under the old rules. In order to protect itself from making zero or a negative margin on the placement, the agency is faced with four options:

  1. Increase the margin the client pays to cover the £14 of employer costs -> Many clients will push back on this.
  2. Renegotiate the ‘limited company rate’ by reducing it by £14 -> Many contractors will push back on this.
  3. Maintain the status quo and make no margin or suffer cost -> Not commercially viable for the agency.
  4. Eliminate the PSC from the supply chain (thereby removing the requirement to pay the employer costs on top of the limited company rate, as no PSC means the new IR35 rules do not apply), by ensuring that the contractor works only via the agency payroll at the PAYE rate or via an umbrella company at the limited company rate.

It’s time for transparent umbrellas

Transparency over these different types of rates has always been critical to maintaining a healthy relationship between a contractor, their agency and umbrella company

More established umbrella companies have on the whole been transparent about the net take-home pay and employer costs for years. However, there are many new umbrella companies setting up in advance of the IR35 changes which do not have the knowledge and experience to manage this issue. 

Regulation of umbrella companies is on the horizon and I envisage this being a key factor to consider by the regulator. The KID is a useful document, in that it mandates that the agency is transparent. The next step is to mandate the umbrella companies are also equally transparent.

What will happen after April 2021?

We will all have to wait and see what the full impact of the April 2021 rollout of the IR35 off-payroll changes have on contract rates and engagement methods. Based on the false start in the run up to April 2020, I envisage umbrella company working or agency payroll being the primary option available to contractors found to be inside IR35

If this is the case, contractors will require flexible ways of working that will enable them to continue working outside of IR35 via their PSC whenever possible, while accommodating umbrella and agency payroll work when it is required.

Wednesday 29th Jul 2020
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Written by Matt Fryer

Matt is a Chartered Tax Advisor with 18 years' experience of advising on tax planning and compliance. Matt has been with Brookson since 2009, having previously worked for Big 4 accountants, KPMG and PwC. Matt’s primary role is to ensure that the services provided by the Brookson Group comply with relevant legislation and regulatory requirements. Matt is also a Board member of the FCSA, the UK's leading membership body dedicated to promoting supply chain compliance for the temporary labour market.

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