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Off-payroll rules and R&D relief for employment costs

18 March 2020

See BDO's Off-payroll labour tools

New tax rules for off-payroll labour in the private sector are due to begin on 6 April 2021, as detailed here.

The changes will affect medium and large businesses that engage workers operating through an intermediary. An intermediary is usually a worker’s personal service company, but could also be a partnership, a managed service company or an individual.

Currently, the responsibility lies wholly with the intermediary to ensure that the off-payroll rules are reviewed and applied as necessary. From April 2021, it will be the responsibility of the organisation receiving the worker’s services (the client) to determine whether the rules apply.

Using on-payroll employees

With financial consequences for failure to implement the new rules correctly, as well as the additional administration and time needed to ensure the rules are applied correctly, a number of large organisations have recently announced that from April 2021 they will cease to engage workers outside of the payroll; all workers will be subject to PAYE. This will avoid the need to consider and implement the off-payroll rules.

Being an employee, rather than a worker, will mean an increased tax and NIC bill for the individual. However, it will mean they are entitled to the benefits of being an employee, such as holiday pay and sick pay.

Whilst becoming an employee may be unwelcome news for many workers, for companies engaged in research and development (R&D) activities this approach may provide additional corporation tax relief or Research and Development Expenditure Credits, which themselves are reported in pre-tax earnings, thus offsetting part of the salary expenditure reported in the Income Statement.

R&D relief for staff costs 

Although adding workers to the payroll will increase the business’ employee costs due to employer NIC and pension contributions being payable by the employer in addition to the salaries, companies submitting R&D claims to HMRC may be able to claim a greater tax deduction or increased R&D Expenditure Credits for these costs.

Companies who employ employees and directors who are directly engaged in R&D work are able to claim a 130% deduction, in addition to the usual 100% deduction, for the associated staffing costs under the SME R&D scheme, or a 12% above the line R&D Expenditure Credit where they are Large for R&D purposes. As well as salaries attributable to qualifying R&D activities being eligible for inclusion as “qualifying staff costs”, companies are also able to include the relevant proportion of the employer NIC, the employer pension contributions and certain reimbursed business expenses. Loss-making companies of all sizes may be able to surrender their loss for cash.

Companies who use contractors to carry out the same work and are claiming R&D relief under either the Large or SME R&D scheme will, broadly, only be entitled to a deduction of 65% of the associated costs. (Costs relating to workers who are considered to be deemed employees under the off-payroll rules will also only be eligible for a 65% deduction).

Next steps

The interaction of the off payroll labour rules and R&D tax relief, and the potential additional R&D qualifying expenditure available, is one factor that should be considered when deciding how to prepare for the incoming legislation. However other factors should also be considered, such as whether making workers employees will make your business less attractive and affect the business’ ability to attract and retain the right people.

For more information on how the off-payroll rules work or what deductions are available under the R&D schemes, please get in touch with your usual BDO contact or one of our Employment Tax specialists or R&D specialists.