COMPLIANCE
controls and segregation of duties, to ensure all aspects of the payroll have been diligently checked for accuracy and accountability. We’re all adept at working around challenges within our employee population to ensure our teams are paid on time each pay period, and submissions to HM Revenue and Customs (HMRC) are accounted for. The dawn of the requirement to operate payroll for non-employees, i.e. a company or intermediary, increased the challenge further. The solution seemed simple: take the invoice payment details and operate them through payroll, accounting for the PAYE tax and National Insurance contributions (NICs), remembering not to actually submit payment through payroll. The reality is an intricate balance of agreeing which payment items are eligible for inclusion in payroll for PAYE and NIC purposes. Here we take you through each step of the process to avoid the commonly cited pitfalls: Status determination The first step is to ensure the accuracy of employment status determinations. This may or may not fall on payroll teams. However, clearly establishing when a contractor is deemed to be employed (and therefore falls within the scope of the IR35 rules) is vital for payroll operations to begin. Excluded pay items It’s important to know what to include as pay for the purposes of PAYE and NICs. As the contractor will still be submitting an invoice, payroll teams should connect with their accounts team to agree which invoice pay items should be included for payroll purposes. The value which needs to be operated through payroll, and that you’ll be responsible for calculating, is called the ‘deemed direct payment’. This payment should ultimately be a contractor’s labour or time value. Any items that don’t constitute a contractor’s labour or time value should be excluded. Some points for consideration on this are listed below: 1. The most common of these items is value added tax (VAT). 2. Genuine business expenses should also be removed but be aware that some ‘expense items’ values shown on the invoice may not actually correlate to
the genuine expense cost. If in doubt, evidence of expense cost should be obtained from the contractor, or the full expense item value should be included for payroll operation purposes. 3. Professional subscriptions are akin to a genuine business expense and as such, should be excluded from payroll operation. Carefully check whether the invoice value correlates to the actual professional subscription costs, with evidence being requested for accuracy and compliance purposes. 4. The cost of materials is deemed a genuine business expense and therefore should be excluded. Care should be taken to establish whether the invoice value correlates to the actual professional subscription costs, with evidence being requested for accuracy and compliance purposes. 5. Where you aren’t comfortable reconciling any of these ‘expense’ or ‘cost of material’ item values, the total amount should be included within the deemed direct payment for payroll purposes. 6. Contractors may itemise separate costs, for example, for different project milestones, equipment use or scope overruns. Where these aren’t either VAT or genuine business expenses, all these costs should be included within the deemed direct payment as labour value or time value and be operated through the payroll. Apprenticeship levy Where an organisation meets the terms which require the apprenticeship levy charge to be paid, this will equally apply to the contractor payroll operation. Therefore, when accounting for PAYE and NICs on the appropriate invoice value, the apprenticeship levy charge should also be calculated and paid. What shouldn’t be accounted for Student loan deductions shouldn’t be operated through payroll for any contractor deemed to be employed due to being caught within the IR35 rules. Instead, these deductions should be accounted for by the contractor through their tax returns. Statutory payments, for example, sick pay or maternity / paternity pay should come through their employment with their own limited company and so, shouldn’t be included in payroll. The organisation isn’t responsible for the provision of any employment benefits,
including pension, private medical insurance, etc. Responsibility for these types of employment benefits should be through the contractor’s employment with their limited company. Tax codes A contractor’s primary employment should be with their limited company, generally as a director and employee. When setting up the payroll, tax code BR may be the most appropriate to use. This may vary depending on specific circumstances, and HMRC should notify the organisation of any change or update to the tax code that may be required. Net pay, or not? The operation of payroll for deemed employees engaged through their own limited companies is a PAYE and NIC collection mechanism only. Therefore, as the contractor’s invoice should be paid through your accounts team’s systems, and the net pay calculation should be reconciled to nil, to avoid potential duplicate payments.
Confirmation statement For completeness, confirmation
statements of the value of the payment made through payroll each pay period, together with the PAYE and NIC deduction values, should be provided to the contractor. This should also be retained for the organisation’s records. Finally, payment to the contractor Once all the above has been completed and the accounts team has received the net pay instruction from payroll, they’ll need to add back the expenses values, cost of materials and the VAT to reconcile the final payment to the contractor. Structure, planning and process There are many steps to be taken to ensure accuracy of the ultimate pay value to be included in the payroll for PAYE and NICs purposes, but also to ensure the correct payment is made to the contractor by the accounts team. For the most efficient process, communication between all stakeholders, and particularly the payroll and accounts teams, is key. By planning in advance and establishing clear guidance, organisations can implement an efficient process for all stakeholders and departments. n
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| Professional in Payroll, Pensions and Reward |
Issue 114 | October 2025
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