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Is there a tax risk if I employ a contractor?

You may be exposed to large tax risks by employing contractors. Whilst recent tax legislation (aka “IR35”) affects only public sector organisations, it has thrown the spotlight on how contractors, even in the private sector, are paid. You may be exposed to an unnecessary tax risk.

First the good news.  To the extent that you pay your contractors via a third party company – limited company or limited liability partnership – then any tax risk will ultimately reside with this entity and not your company.

Where you should show caution is in paying contractors directly into their personal bank accounts.  The longer in time you employ such individuals (years rather than months) and the more regular their hours, then the greater your exposure to unnecessary tax risks.

What is the size of this risk? Having to pay all personal income tax, plus national insurance taxes on historic payments to contractors will amount to 45% of such payments even for basic rate tax payers.  HMRC penalties and interest can double this and for higher tax rate contractors your liability will increase yet further.  So in summary, your exposure can easily equate to whatever you have already paid such contractors and perhaps more.

In all circumstances, an arms-length contract should support such work and make sure that these individuals do not have the characteristics of employees (see specific HMRC webpage).  Better still, insist that for long term assignments, contractors must engage with you via a 3rd party entity which is then where the liability resides.

Finally, you need to take care of any payments made to your own Office Holders (directors or company secretary) via their own companies – Personal Service Companies (PSCs).  HMRC rules will inevitably classify such payments within the scope of IR35 legislation meaning that PAYE and National Insurance are due on such payments.  It’s the Office Holder status that causes the problem, although the liability rests with the PSC and not your main company.