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Going off Payroll - Why it can be a Good Idea

HR Review, May 2012

The recent political storm about the number of senior civil servants who are not being paid ‘on payroll’ but are remunerated by either a managed service company (MSC)  or employment agencies  has highlighted an issue about the importance about the terms on which people are engaged to work for employers or clients and –in the public sector – the reputational risk that this can cause.

The revelation that around 2,400 government employees (earning a minimum of £58,200 per annum) have been paid through these alternate arrangements have got the Government, MPs and interested bodies such as the Taxpayers’ Alliance very hot under the collar and demanding that these arrangements must come to an end. Something that the coalition government is keen to stamp out through seeking assurances from individuals that they are paying the correct Tax and National Insurance contributions.

However, whilst it seems clear that these individuals may well have benefited from reduced taxation by being engaged off payroll, little consideration seems to have been given that one of the reasons these arrangements are proposed and  continued is that this a  significantly cheaper method of ‘employment’ and offers better value for money for employers- in this case the Government which means taxpayers.

By being engaged (rather than being employed) through this arrangement, it does mean that the employer does not have to pay any employer’s National Insurance Contribution (NIC) nor pension contributions. If you look at a worked example of employing these people by putting them on the payrolls it can be seen that an employer (in this case, the taxpayer)  would almost certainly be far worse off:

Fee paid via service company arrangement: £58,200
Salary if paid on payroll: £58,200
Employer’s NIC (13.8%):   £ 8,032
Employers pension contribution (15%): £8,730
Total cost per person   £74,962

This suggests that for each of the 2,400 people engaged via service companies or other agencies that the additional cost of putting them ‘on payroll’ could be as much as £16,762 or a total of £40 million, and this is almost certainly an under estimate as it assumes that the average fee paid is £58,200 and the pension contribution is based on an average figure paid by a number of large private sector companies, when for the public sector it is likely to be much higher.

Assuming that individuals are currently paying 20% corporation tax instead of 40% income tax, the increased tax take per person would be £11,640 or a total of £28m. So in effect, it would cost the employer/tax payer a further £40m to raise £28m  – a net deficit of some £12m- which just makes no sense.

However such is the political outcry about the current arrangements that the fact that putting people ‘on payroll’ will cost the taxpayer more money has been, I would suggest sidelined.

In addition, as an employee these individuals would also be liable for other worker benefits such as sick and holiday pay, unfair dismissal rights, redundancy entitlements etc, whilst being engaged through a service contract would probably not require any termination payments as the contract could just not be extended and be cancelled on its expiry.

The implications for all employers were they to advocate such steps for their ‘workers’ could be immense. Employers need a genuinely flexible workforce especially in the current climate, they may not want (or afford) to permanently employ someone on a discreet project and engaging them through a service contract, or as a self employed person or indeed via a recruitment agency would meet their needs.

The financial case for not putting someone on payroll is strong – it is cheaper, it is more flexible, it requires less management and for the person who does not want tenure of employment and the rights that follow, it often suits them too, as it is clearly tax advantageous to them in most cases. This all falls under the Intermediaries Legislation (IR 35) in helping to determine if someone engaged for a client is actually ‘employed’ or not which will determine the tax treatment, so HR professionals need to carefully consider if people they intend to engage in this way would meet that test or not.

Author: Bryan Matthew

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