How to pay contractors in the UK

Keeping the outsourced contractor process flowing is a must, as today many businesses rely on non-salaried staff to plug resourcing gaps. Paying contractors may well run parallel with payroll services, but there often are distinct differences in the system used. Together with as always, the requirement for payroll teams to make contractor payments compliantly and accurately.

Classify your staff correctly

Start as you mean to go on by ensuring you understand who the contractor is and how they file their taxes, along with your obligations to them and their employment rights. Classifying staff is understanding whether they pay tax directly to HMRC on an individual basis, or if payroll services have to work out their tax owed and pay it to HMRC through Pay As You Earn (PAYE).

In the UK, according to HM Revenues & Customs (HMRC), employment status can be simply classed as the following:

• Self-employed contractor
  Someone who works for themselves and self-report their taxes, which they calculate and pay directly to HMRC.
• Worker
  Someone who is usually subcontracted or temporary staff and taxed through PAYE.
• Employee
  Someone who is a contracted member of staff with specific statutory rights and taxed through PAYE.

Under these topline explanations, there are many intricacies to each employment status that global payroll teams need to be across, so knowing where a contractor sits on this continuum is key. Ordinarily, contractors fall outside the PAYE system and are not taxed at source, so it is their responsibility to do their own tax returns and organise their own National Insurance Contributions (NICs). A nice bit of admin load taken away from HR and finance departments, especially busy payroll for small business teams, you might think. However, an entirely different contracting and payment process may well be required to ensure contractors are paid seamlessly.

Not sure on a person’s employment status? Take a peek at the HMRC’s Employment Status Manual (ESM) to find out more here.

Draft a clear contract

Knowing where everybody stands is what a contract is all about: it’s in the name ‘contractor’ for a start. Before undertaking a role, payroll services should draw a contract up that clearly lays out everyone’s expectations for what needs to be delivered and when.

A contract is the who, what, when, where and how of a contractor’s job, whether paying them directly or through an intermediary agency. Any contract should deal with the following areas in detail:

1. Scope of work: What is and isn’t included in the work.
2. Duration and delivery: How long is the job and the delivery schedule.
3. Payment terms: Agreed fee or hourly rate, overtime rate, agreed expenses and payment timescale.
4. Contract termination conditions: How to end the contract, from both the employer and contractor side.

Laying all this out from the beginning of the work covers both parties, so future queries or disputes can be easily resolved.

Understand IR35 legislation

When employing a contractor via an agency or intermediary company, like a personal service company, there is HMRC’s specific IR35 legislation to adhere to. The IR35 rules apply to ‘off-payroll’ working, where a contractor might bill their services via a company, rather than as a self-employed person, to bypass tax obligations and monies owed.

Global payroll and payroll for small businesses alike must be across IR35 legislation as it brings contractors into step with their income tax and NICs responsibilities, closing the tax avoidance loophole. However, this can mean bringing these PAYE and NICs calculations back into payroll services, so contractors are taxed at source like employees or workers. Yes, more work for payroll teams but essential for tax compliance and fairness.

Get to know the IR35 rules inside out, but if you’re not sure where your business or contractors fall within these rules, then seek advice from a payroll professional like ADP.

Determine the payment schedule

Time is always a factor in the workplace, as they say: time is money. Freelancers and contractors won’t necessarily have the monthly or weekly salary payments that long-term employees are privy to, so cashflow is paramount to them. Agreeing and administrating a payment schedule needs to work for both employer and contractor, whether that’s on delivery of a project or regularly if the work is ongoing. Outlining the payment terms, e.g. payable within 30 days of receiving the invoice, is best done by payroll teams at the contract stage but may well be included in the contractor invoice itself. Keep contractors aware if something in the payment terms is amiss, so they can resolve any issues and prepare for any payment delay, then plan accordingly.

Invoice processing

When payroll teams get an invoice in for processing, this might be done through a separate system to employee payroll, depending on the company setup. It’s important HR and finance teams are versed on both the internal and external side of the global payroll process.

Here’s a quick step-by-step checklist when you receive an invoice:

1. Verify that work has been completed. Check with the relevant department that it has been done to the expected standard.
2. Check the amount on the invoice matches. For payroll for small business, this will be the originally agreed rate or quote, whereas for larger or global payroll services you may use an internal purchase order system.
3. Double-check the contractor’s details. This includes contract or company name, address and contact info.
4. Look at tax information. Are they under IR35 rules or self-employed?
5. Reread the payment terms. Are they as agreed and realistic?

If you’re happy the invoice meets all these criteria, then you can add it to your system and process, ready for payment.

Making payments

There isn’t one way of making contractor payments, each employer and contractor is different and has their own way of working. Paying contractors can be done through various methods, such as modern online payment platforms, traditional bank transfers and even still by cheque. To be honest, most freelancers don’t mind how the money comes in as long as they do get paid, and ideally paid on time.

As we’ve seen, typically contractors sort out their own tax filings, so they are not taxed at source through PAYE like employees and workers. Contractors are responsible for working out their own tax burden via HMRC’s self-assessment tax return and paying it directly to HMRC themselves. Therefore, payroll services do not to take these calculations into account when making contractor payments. Usefully, for hectic payroll teams, contractor payments are often just the amount on the invoice without VAT, so processing and calculating is reasonably straightforward.

Reporting to HMRC

With self-employed contractors acting separately to other staff, you don’t need to roll up these contractor payments into your usual employee payroll. So, no need to input these into the HMRC’s Real Time Information (RTI) payroll submissions as you go. Excellent, one less processing and reporting step for you. But remember, you still need to keep accurate records of all contractor payments in case of an audit by HMRC.

However, when it comes to contractors under IR35, the onus is back on payroll services to calculate and deduct tax at source on their behalf. This must be accurately declared to the HMRC and included in your company tax return, as per any other employee or worker. Failure to comply and declare in a timely fashion can mean fines and legal action, so make sure to include any IR35 contractors in your payroll process. Ideally, payroll services should implement the latest payroll software that can understand these complex IR35 ins and outs — so you don’t get caught out.

Stay informed

The UK taxation system is a living, breathing thing that is being updated and tweaked all the time. It is the responsibility of HR and finance departments to keep themselves in the loop about any new employment legislation or HMRC tax changes, no matter if you’re a massive global payroll or a teeny payroll for small business team. You really don’t want to drop the ball as the penalties can be dire, so payroll services should be future forward.

Maintain a close eye on the industry through HMRC emails and updates, financial news and government budget announcements, and by belonging to relevant professional bodies with experts that can decipher new laws and understand how they’re put into practice. A good payroll solution will include access to people who are clued-up on taxation and legislative changes, swiftly adding it into any payroll software so you’re ready to adapt straight away.

Find out how ADP can help you pay your employees accurately, compliantly and on time