Subcontractor & freelancer costs

Conditions

1. GOV.UK's self-employed expenses guidance lists subcontractors among the staff costs you can claim. For both sole traders and companies the test is statutory: section 34 ITTOIA 2005 and section 54 CTA 2009 prevent a deduction unless the expenditure is incurred wholly and exclusively for the purposes of the trade (BIM37007).
2. Check the worker's employment status first. HMRC's check employment status for tax (CEST) tool gives HMRC's view of a worker's employment status, based on the information you provide, and HMRC says it will stand by all results given by the tool, as long as the information you give remains accurate and is in accordance with its guidance.
3. The off-payroll working rules (IR35) apply if a worker who provides services to a client through their own intermediary — usually a limited company — would have been an employee if they were providing their services directly to that client. They apply contract by contract.
4. Where the client is a public authority, or qualifies as medium or large and has a UK connection, Chapter 10 of Part 2 ITEPA 2003 applies (section 61K). The client is responsible for determining the worker's employment status for tax and should produce a status determination statement (SDS) including the reasons for its determination.
5. If the worker is deemed employed, the deemed employer must deduct Income Tax and employee National Insurance from the fees paid to the worker's intermediary, and pay employer National Insurance and any Apprenticeship Levy to HMRC. The deemed employer is generally the fee-payer — the person in the chain immediately above the worker's intermediary — but it is the client until the client gives the worker an SDS, and other rules in section 61N ITEPA 2003 can move it.
6. Where the client is small and outside the public sector, the worker's intermediary is responsible for deciding the worker's employment status and if the rules apply. Whether a company client is small turns on Companies Act 2006 tests that section 60A ITEPA 2003 imports, such as whether the small companies regime applies to it. A client that is not a company is not tested under that section, and other provisions look at its turnover, so either way check it with an accountant.
7. In construction, the Construction Industry Scheme (CIS) applies. You must register as a contractor if you pay subcontractors to do construction work, or if your business does not do construction work but you have spent more than £3 million on construction in the 12 months since you made your first payment. You may be a sole trader, in a partnership or own a limited company, and you must register before you take on your first subcontractor.
8. Before you can pay a new subcontractor you must verify them with HMRC, which tells you whether they are registered for CIS and what rate of deduction to use or if you can pay them without making deductions. You usually make deductions from their payments and pay the money to HMRC; the deductions count as advance payments towards the subcontractor's tax and National Insurance. Deductions are taken at a higher rate if the subcontractor is not registered. You must also verify subcontractors you have used before if you have not included them on a CIS return in the current or last 2 tax years. You must file monthly returns and keep full CIS records, and you may get a penalty if you do not.
9. CIS also requires you to check if you should employ the person instead of subcontracting the work; GOV.UK warns you may get a penalty if they should be an employee instead.
10. CIS covers most construction work to a permanent or temporary building or structure and civil engineering work such as roads and bridges — including site preparation, demolition and dismantling, building work, alterations, repairs and decorating, and installing heating, lighting, power, water and ventilation systems. GOV.UK's exceptions include architecture and surveying, scaffolding hire with no labour, carpet fitting, making materials used in construction, and delivering materials.
11. Employees have no specific relief for paying subcontractors or freelancers. An employee's general deduction is under section 336 ITEPA 2003, which HMRC calls very restrictive: all of its tests must be passed (EIM31630).

Common mistakes

• Treating a worker as a subcontractor without checking whether they should be an employee. GOV.UK warns CIS contractors they may get a penalty if the worker should be an employee instead.
• Paying a new construction subcontractor before verifying them with HMRC, which is what tells you the rate of deduction to use.
• Assuming the worker's own company decides whether the off-payroll working rules apply when your business is a public authority, or is medium or large and has a UK connection. Outside the small-client case, the client is responsible for the status determination.

What to keep

• Contracts or written agreements with each subcontractor or freelancer, describing the work scope and fee.
• Invoices from subcontractors or freelancers showing the services, amount and date.
• For an off-payroll engagement, the status determination statement and its reasons. GOV.UK says a CEST result can be used as a valid status determination statement.
• For CIS: your contractor registration, subcontractor verification records, monthly CIS returns and full CIS records.

Real-world example

A building contractor engages a new electrician for £8,000 of wiring work. Installing a power system is construction work within CIS, so before the first payment the contractor verifies the electrician with HMRC, which says whether the electrician is registered and what rate of deduction to use. The contractor deducts at that rate, pays the deduction to HMRC and includes the payment on its monthly CIS return. The deduction counts as an advance payment towards the electrician's own tax and National Insurance.

Frequently asked