Part of the flock
Part of the flock
A Guide to: Employment status
Individuals who are employees are entitled to employment rights such as pension provision, sick pay, paid holiday, parental leave and the ability to claim redundancy and unfair dismissal
Self-employed individuals are responsible for reporting their income to HMRC and will pay income tax and NI contributions via self-assessment
When considering their status in tax law you should consider the points laid out in this article.
There has been a lot of media coverage of employment status in recent times; this has largely related to what is seen as the exploitation of individuals by large corporations through classifying them as self-employed and therefore denying them employment rights. However, an individual’s employment status also has important tax consequences, as shown by the tax cases involving high-profile TV personalities which have also received a lot of airtime.
Employee vs Self-employed
Individuals who are employees are entitled to employment rights such as pension provision, sick pay, paid holiday, parental leave and the ability to claim redundancy and unfair dismissal. The employer will be responsible for deducting PAYE and NI from their salaries and paying these amounts over to HMRC.
Individuals who are self-employed are not entitled to the employment rights set out above and will receive their income without any deduction of tax or NI. They are responsible for reporting their income to HMRC and will pay income tax and NI contributions via self-assessment.
Businesses have to pay employers NI contributions on top of an employees salary and make pension contributions (subject to the auto-enrolment rules) but there are no such requirements when paying self-employed individuals. The combination of these cost savings and the restricted rights of self-employed individuals is why many businesses prefer to engage people as self-employed rather than employees. However, HMRC will look at the substance of the engagement rather than the description used by the business to determine how the classification for tax purposes.
Engaging self-employed workers
There are many genuine self-employed individuals. The employment legislation around this topic is vast and continues to evolve as society changes.
HMRC may regard someone as self-employed for tax purposes even if they have a different status in employment law. Tax law covers whether they’re exempt from PAYE whereas employment law determines whether they have an employee’s rights.
When considering their status in tax law you should consider the following points – they should not be paid through PAYE if most of the following are true:
- They are in business for themselves, are responsible for the success or failure of their business and can make a loss or a profit
- they can decide what work they do and when, where or how to do it
- they can hire someone else to do the work
- they are responsible for fixing any unsatisfactory work in their own time
- their employer agrees a fixed price for their work – it doesn’t depend on how long the job takes to finish
- they use their own money to buy business assets, cover running costs, and provide tools and equipment for their work
- they can work for more than one client
When considering their status in employment law you should consider the following points – they do not have employment rights if they are exempt from PAYE and most of the following are also true:
- they put in bids or give quotes to get work
- they are not under direct supervision when working
- they submit invoices for the work they have done
- they are responsible for paying their own National Insurance and tax
- they don’t get holiday or sick pay when they’re not working
- they operate under a contract (sometimes known as a ‘contract for services’ or ‘consultancy agreement’) that uses terms like ‘self-employed’, ‘consultant’ or an ‘independent contractor’
Company directors have different rights and responsibilities from employees, and are classed as office holders for tax and NIC purposes. If a person does other work that is not related to being a director, they may have an employment contract and get employment rights, as set out above.
A person who’s been appointed to a position by a company or organisation but doesn’t have a contract or receive regular payment may be an office holder, this includes statutory appointments such as registered company directors.
Someone is likely to be an office holder rather than an employee if most of these statements apply to them:
- there is no contract or service agreement relating to their appointment
- their duties are minimal, and are only those required under the relevant statute, constitution or trust deed
- they don’t get a salary or any other form of regular payment for their services
- the only payment they get is a voluntary payment (honorarium), regardless of the work they do – tax and National Insurance are deducted by the appointing body
- they’re effectively working as an independent office, and are not under the close supervision or control of the appointing body
Where a self-employed contractor is determined, usually as a result of a PAYE enquiry at the engaging company, to be an employee, the company will be liable for any PAYE and NIC that should have been deducted on gross payments made, plus Employers NIC. Credit is commonly given for the income tax and NIC paid by the contractor via self assessment.
Interest will be charged on the underpaid amounts at HMRC standard rates.
HMRC calculates penalties for lodging inaccurate PAYE/national insurance returns as a percentage of the total amounts that should have been paid for up to six years. HMRC does not take account of income tax or national insurance paid by the worker under self assessment during this six year period when calculating penalties. The penalty percentage will depend upon the level of intent and concealment. HMRC do not charge penalties if they consider that an error arose despite the taxpayer taking reasonable care. Where HMRC believe the error arose due to a lack of reasonable care penalties could range between 0 and 30%. If they believe the error was deliberate the penalties will be between 20 and 70% of the underpaid tax, and if the error was deliberate and efforts were made to conceal it the penalty range increased to 30 to 100%. The exact percentage applied within these ranges will depend on how helpful the company is whilst the error is being dealt with – this includes things such as declaring the error in a timely manner and providing all of the information that HMRC request.
What is IR35?
In order to circumvent the above rules many people set up companies to direct their remuneration through, as a company cannot be classified as an employee. In response HMRC introduced IR35. Properly known as the Intermediaries Legislation, IR35 is designed to reduce tax avoidance by workers, and the firms hiring them, who are supplying their services to clients via an intermediary, such as a limited company, who would be an employee if the intermediary was not used.
Determining whether an individual is caught by IR35 is complex but there are 3 main principles to determine employment status, known as the ‘tests of employment’:
- Control; what degree of control does the client have over what, how, when and where the worker completes the work
- Substitution: is the personal service by the worker required, or can the worker send a substitute in their place?
- Mutuality of obligation: mutuality of obligation is a concept where the employer is obliged to offer work, and the worker is obligated to accept it.
Other factors are then taken into account to determine whether a worker is caught by IR35 including the contract type, whether they are taking a financial risk, if they are ‘part and parcel’ of the engager’s organisation, being in business on their own account and provision of equipment. These points are looked at in the round and if the balance of probabilities is that the worker is an employee then IR35 applies.
Currently, where a private sector business engages a contractor through a Personal Services Company (‘PSC’), liability to decide whether IR35 applies and to pay any employment taxes rests with the PSC. If caught by the legislation a PSC is required to calculate the deemed payment and account for PAYE and NIC accordingly.
An engager, or client, under the existing rules is not liable for any further taxes where a worker is caught by the IR35 legislation, irrespective of whether the PSC they operate through correctly applies the legislation.
New legislation known as the ‘off-payroll working’ rules changed for the public sector in 2017 but the implementation for the private sector has been delayed to 2021. Whilst these changes are not covered here, they show that this is an area that HMRC are interested in and will continue to pursue.
How Ashcroft can help…
While the answer to the question ‘are you employed or self-employed?’ seems simple, the intricacies of employment tax are complex, and our advice and experience can help guide you through the most awkward bits!