Payments to individuals outside payroll

Running a business can come with many problems, especially when it comes to outsourcing work and paying employees that aren’t on your typical payroll system. Setting up payroll can be difficult enough, but paying people outside of it can be a completely different problem.

As payments to individuals outside payroll could expose companies to high additional tax liabilities and penalties, we have set below a brief summary and precautions that the company could take to minimise any risks.

Employment status

The employment status of an individual under tax law may be different from the employment status of someone under employment law. As a result, payments made to an individual may be required to be run through payroll even when a company has not made a decision to employ them e.g. for contractors, or has used their services for a very short period e.g. casual workers, interns or if they are directors.

Before making payments to individuals, it is the responsibility of the company and directors to check the employment status of the individual.

If HMRC does not agree with the employment status, they could seek to treat the payments made to individuals as net of tax and NI and recover the PAYE and NI from the company on the gross amounts (in addition to penalties and interest).

There are however ways that the company could reduce these risks as below. (Ideally all 3 should be used).

1. Pasted below is the link to the HMRC tool which can be used to check a contractor or individual’s employment tax status. Provided you enter the details in the questions correctly, and you save a copy of the results, HMRC will abide by the result i.e. if the result is that an individual is not required to be on payroll.
   Check employment status for tax – GOV.UK
2. Ensure that you have written contracts with contractors confirming that they are self employed and that they are responsible to making their own tax payments from the amounts received and that they will reimburse the company should HMRC assess the company for any taxes on these payments.
3. Ensure that the company receives and retains invoices for all payments made to the individuals outside payroll.

Payments to self employed and contractors

A person is self-employed if they run their business for themselves and take responsibility for its success or failure. Self-employed workers are not paid through PAYE, and they do not have the rights and responsibilities of an employee.

A worker must tell HM Revenue and Customs (HMRC) if they think they have become self-employed.

Someone can be both employed and self-employed at the same time, for example if they work for an employer during the day and run their own business in the evenings.

Payments to directors

In most cases payments to directors, whether as individuals or through their personal companies, are required to be put through payroll irrespective of whether or not they provide an invoice.

Directors can withdraw from a limited company either by salary or dividends as detailed below.

Director’s salary, expenses and benefits
The most familiar method of taking money out of a limited company is for the directors to pay themselves a salary. Company directors are still employees of the business, and they will need to be registered with HMRC for PAYE and pay National Insurance Contributions on their earnings.

Dividends
Directors can take dividends from their company as long as it has the reserves to do so. Dividends are paid out of the company’s profits after corporation tax has been deducted.

If a director takes money from a limited company and it is not in the form of a salary or dividend, this is known as a director’s loan. All transactions of this type must be recorded in a directors’ loan account, which keeps a running balance of any transactions between the director and the company.

If a director’s loan account becomes overdrawn (i.e. the director owes the company money), and if the overdrawn amount is not repaid within 9 months and one day of the company’s financial year end, there would be corporation tax chargeable on this balance at the rate of 32.5% (2022-23). If the directors loan account is overdrawn by more than £10,000, the sum must be declared on the director’s self-assessment tax return with the appropriate amount of tax. You should take advice from tax experts before doing this.

Payments to contractors and individuals outside the UK

When engaging the services of individuals abroad, the company may still be required to register and run payroll in the country in which the individual is based.

Engagements with overseas off payroll workers need to be reviewed to establish if the worker is UK resident so care should be taken where these types of arrangements may become more popular. It is also necessary to consider if the arrangement with a contractor working overseas triggers any issues in the overseas country.