Getting to Grips With Subcontractor Tax Issues

Businesses use subcontractors all the time. Perhaps they need them on a temporary basis to inflate their workforce for a busy period? Maybe they require specialist skills for a particular project that they do not possess in-house? There again, they might want subcontractors involved in the mix because they offer greater employment flexibility than putting workers directly on the payroll. It all depends.

Of course, subcontractors provide a great deal of adaptability that makes them ideal for anyone dealing with changing market conditions or the usual ups and downs in their own workforce provision. What many people in business fail to understand fully, however, is how the use of subcontractors impacts on taxation.

In this guide, you will find out the basics of subcontractor tax, what the difference is between general contractors and subcontractors in terms of taxation, and where responsibilities lie for things like National Insurance and income tax. If you have ever considered using subcontractors in your business but been put off the idea because you don’t know enough about tax regulations, then read on.

Employees Tax Versus Subcontractors Tax

To begin with, UK firms are all supposed to pay the tax that is due from employees on their behalf. In other words, if you have an individual on your payroll, then their National Insurance Contributions (NICs) should be deducted from their weekly pay or monthly salary and paid to HMRC on their behalf. The same goes for employer NICs and income tax.

This is the well-known pay as you earn (PAYE) system that has been around for decades. However, paying a subcontractor to do work for you means being able to legally bypass this system. In other words, when subcontractors carry out work for your business, even if they do it in your company’s name, they are not deemed to be an employee and no PAYE calculations or deductions are needed.

Instead, the subcontracting firm will need to carry out all of the necessary PAYE processes for employees on their payroll. To be clear, subcontractor tax is the responsibility of the subcontracted firm, not the business passing them work. This is one of the big advantages of using subcontractors in the first place, of course. Once a price has been agreed, that is all you pay – you don’t have to then factor in taxation.

Main Contractors and Subcontractors – Corporation Tax, Income Tax and National Insurance

If you appoint a contractor to do work on your company’s behalf, then – as mentioned – that company is responsible for the PAYE tax of any workers it has on its payroll. They should pay the income tax and national insurance that is due even if those individuals have been working for you. So long as there is a genuine contractor operation in place, this is the correct way of dealing with tax.

When contracting firms are run as certain types of partnerships or as limited liability companies, they will also need to pay corporation tax. This is distinct from freelancers or contractors who operate as sole traders who do not need to pay this type of tax. Corporation tax means company directors often pay less personal tax. The point is that this is the responsibility of the contracted firm, not the company procuring its services.

The same goes when a main contractor subcontracts some or all of their work to third-parties. The personal taxation that is due becomes the responsibility of the firm or self-employed individual who is doing the subcontracting. In other words, subcontractor tax is never something companies which outsource all or part of their work need to worry about, regardless of whether work is contracted and then subsequently subcontracted.

The Construction Industry and Subcontractor Tax

So far, you have read about what goes on in most industries in the UK. In Ireland, similar rules apply but there are some differences, as you will see. This system would be in place whether you are talking about subcontracted training services, IT services, waste collection or virtually any other sector. Nevertheless, different rules apply to construction workers.

This is due to HMRC wanting to tighten rules regarding payments to subcontracted construction workers where – historically, at least – tax avoidance was rife. Nowadays, main contractors must pay some tax on their subcontractors’ behalf each quarter rather than leave it to them to declare their self-assessment return annually.

The subcontractor tax due in this sector is regulated by the Construction Industry Scheme (CIS), run by HMRC. Any payments made to subcontractors by main contractors must have a proportion paid to the scheme. At the end of the financial year, any under or over-payments are calculated and these will be settled with the subcontractor accordingly.

Issues in the Republic of Ireland

Although the tax rates vary in the Republic of Ireland compared to the UK, the main principles about how subcontractor tax is worked out remain the same. It is important to note, however, that Irish subcontracting firms do face certain differences. Firstly, since 2012, all main contractors in Ireland have been required to register for the Revenue Online Service (ROS).

Main contractors must use the ROS for their tax returns. In particular, they need to pay subcontractor tax if they operate in certain sectors. For instance, Irish firms working in construction are liable for Relevant Contract Tax (RCT). Sometimes, RCT is zero-rated but the rates can change depending on decisions made by the government and the sort of subcontracted work being carried out.

Indeed, it is not just building firms that may need to pay RCT for any subcontracted construction workers it uses. Companies working in the forestry and meat-processing industries will be liable for some RCT, too. Both main and subcontractors fall under the RCT rules. Generally speaking, RCT rates go up if tax records are not kept up-to-date.

The Benefits of Using Subcontractors

Overall, the way that subcontractor tax works makes it much easier for firms to deal with payroll when they outsource work. Taking on part-time or short contract staff means having to take responsibility for their taxes even if those people already conduct their own self-assessments. When work is subcontracted, this is not the case, thereby making the whole system easier to manage.