Employment status – is someone employed or self employed – is one of the biggest grey areas in the UK tax system, and for businesses one of the most critical areas to get wrong in terms of higher labour costs or unexpected back tax bills.
Issues surrounding Employment Status affect all businesses, regardless of the sector they operate in.
Closely allied to this is the Construction Industry Scheme(CIS). For employers in the Construction Industry this adds extra regulation concerning status onto businesses.
- Why is Status so Important?
- Features of Employment and Self Employment
- Status Tests
- Establishing and Maintaining Self Employed Status
- What if an HMRC Status Challenge is lost?
- Workers with Companies or Partnerships
- CIS – Construction Industry Tax Scheme
- Status – whether a worker is employed or self employed
- Engager – the business engaging a worker on an employed or self employed basis
- Worker – the person working for the engager
- Employed – the worker is an employee of the engager, and subject to employment rights, pay, benefits and deduction for tax/National Insurance.
- Self Employed – the worker is an independent business in a business to business relationship with the engager, and paid a fee for their services, normally without any deduction.
- Status tests – the tests HM Revenue & Customs use to work out whether a worker is employed or self employed
- IR35 – anti avoidance legislation for disguised employment via companies
Why is Status so Important?
Thee are a number of reasons why Employment Status is important:
- Costs to the engager – in an Employment situation Employers NI is incurred which increases employment costs by 15.05% as a headline figure
- Employment rights – issues like holiday pay, redundancy protection and workplace pensions accrue to Employees not the Self Employed – if the wrong employment status is decision is made, then the engagers may be failing to treat workers properly under the law
- Compliance with tax deduction obligations under PAYE or CIS – to do this correctly, status must be known
- Flexibility – both Engagers and Workers may value flexibility in arrangements
- Tax and NI for workers – the worker may be incurring costs which are tax deductible as Self Employed but not as an Employee
It would be wrong to say this is all about tax, its wider than that, neither is it all about Engagers seeking to avoid employment protection and rights – many workers prefer Self Employment for the sense of control over their affairs it gives.
Features of Employment and Self Employment
- Various employment protection rights
- Cannot easily be dismissed
- Workplace health & safety protection
- Redundancy protection
- Paid holidays
- (normally) Sick pay
- Paid under deduction of PAYE (National Insurance and Income Tax)
- Employers National Insurance incurred by engager
- Workers NI at employment rates
- Workplace Pensions
- Little chance for the worker to claim tax deductible expenses
- Little in the way of employment rights – Hire and fire very easily
- Workplace health & safety protection
- No redundancy protection
- No paid holidays
- No sick pay
- Normally paid with no tax deducted (but see CIS rules)
- No employers NI
- Workers NI at lower self employed rates
- Worker can claim an assortment of expenses against tax
There is a half way house of “Limb B Worker” or “Contingent Worker” – sometimes just “worker” – where the worker is Self Employed but gets some Employment benefits – this stems from EU legislation and isn’t a common concern for smaller businesses.
How is employment status determined, and how do you influence this?
There are no statutory tests as to whether a worker is employed or self employed, but over the years the courts have refined a series of rules known as the status tests. The status tests are used to reach a conclusion about employed v self employed status; no one test is determinative in its own right, but some are more important that others – the first three below – Mutual Obligations, Personal Service and Control are the so called “holy trinity” – if any one of them is absent from a purported employment relationship, then the relationship cannot be one of Employment:
- Mutuality of obligations – Mutuality of obligations points towards employment, i.e. the engager is obliged to offer the worker work and the worker is obliged to accept it – non mutuality points towards self employment. Mutuality can occur by custom and practice rather than an express contract.
- Personal service obligations – An obligation to work personally is indicative of employment whereas freedom for the individual to delegate, substitute and sub-contract is indicative of self employment). Contracts of employment do not have rights of delegation, substitution or sub-contract, collectively known as non-personal services rights. Where these rights are included in the contract then it is a strong indicator of self employment. A comparatively recent Court of Appeal judgement, Express & Echo Publications v Tanton (1999), held that where a contract allowed services to be carried out by someone other than the worker then it was a contract for services (i.e. self employment) rather than a contract of service (i.e. employment). However the case law also recognises that where the non personal service rights are a side issue, then they do not carry much weight, eg MacFarlane v Glasgow City Council 2001. Therefore if you are trying to prove self employed status, the non personal service rights must be wide ranging; it is acceptable for any proposed substitute or delegate to be approved by the engager, but they must actually be paid by the worker providing them.
- Control – If the worker is subject to detailed control as to how the work is carried out then this points towards employment – if there is merely measurement against agreed outcomes/deliverables and the worker can undertake the detail of the work in their own manner then this points towards self employment.
Also of persuasive relevance:
- Integration – if the worker is integrated into the engagers organisation then that indicates employment – no integration indicates self employment. Integration in this context could be work as part of a team, inclusion by name on the employers stationary or promotional literature, being on call rotas, inclusion in internal directories, ability to represent the engager to outside parties.
- Method of payment – if the worker is paid by the hour/day/week then that points to employment – being paid for a project or task points towards self employment. Equally the use of time sheet to record hours points towards employment.
- Working hours – if the worker is contracted to work set hours then that points to employment – if the worker is contracted by reference to outcomes/deliverables then that points to self employment.
- Simultaneous contracts – if the worker has only one customer/engager then that points towards employment – if the worker has a number of customers/engagers, and even better if they overlap, then this points towards self employment.
- Risk – little or no commercial risk taken indicates employment – risk indicates self employment. Risks could be responsibility for rectification of errors and mistakes or financial risk of a project overrun.
- Responsibility for losses as well as profits – if the worker is isolated against losses then that points towards employment – if there is a risk of losses then that points towards self employment. Of course with a labour only service, making a loss is difficult, but the general flavour of the contract must be for risk to sit with the worker.
- Provision of equipment – if the engagers equipment is used then that points towards employment – if the equipment is the workers then that points towards self employment. Obviously it is not practical for some very small businesses to provide large items, but PCs for working at home, hand tools, etc, point towards self employment.
- Bearing cost of correcting defective work and errors – if the worker does not bear the risks of correcting defective work and errors then this indicates employment – if the worker does bear this risk, eg by having to carry out remedial work in unpaid time or as part of a fixed price/outcome contract, then that is an indicator of self employment.
- Freedom to choose where and when the work is carried out – being tied to the engagers site and working hours indicates employment – the ability to work at home, or to set ones own hours, self employment.
By themselves none of these persuasive points are decisive, but taken together they help to paint a picture.
To re-emphasise the important factors are:
- Personal service
- Mutuality of obligations
HMRC would also place importance on “Supervision, Direction and Control” separately to the above, but to date the courts have not placed the same importance on this factor.
In Spring 2017 HMRC introduced an Employment Status Indicator Tool – this is a useful checking tool and starting place but may not be totally accurate.
Finally to note – these rules largely stem from Ready Mixed Concrete (South East) Ltd v Minister of Pensions and National Insurance  – there has been no recent legislation or case law. Quite often more recent changes in the legislation around IR35 are mistaken as wholesale changes in the Employment Status rules – they are not.
|Employment Status Considerations|
|Factors indicating existence||Factors mitigating against existence||Notes|
|Mutuality of Obligation||
Establishing and Maintaining Self Employed Status
So, if it is desired to establish or maintain Self Employed status – which tends to be the main concern – how is this done?
First and foremost the important thing is having a Self Employed contract in place. This should cover most of the issues set out in the section above on status tests.
A strong contract will go a long way to protecting a business arrangement. However, it is important that this contract is backed up by real practice and acknowledged by both parties to be effective. To this end it is important that both sides understand the clauses in the contract and their implementation. However the mere fact that a clause isn’t implemented doesn’t mean it’s not valid – however it must be capable of being implemented and not just a sham.
The following are good practices to follow to preserve or establish self employed status:
- Contract – it is important that all self employed operatives have a contract with the engager. In the case of partnerships and limited companies the contract should be between the partnership/company and the engager, not the worker and the engager. It is good practice to renew contracts on a regular basis, eg every new project or every three months.
- Invoicing – it is important that self employed workers invoice the engager for the work they do and they are paid against invoices.
- Advertising – self employed workers contractors should periodically advertise their services social media, local press, shop window, etc, and keep copies of the adverts.
- Business organisation – self employed workers who can demonstrate they have the trappings of a business organisation will fare better in proving self employment. Such trappings could be a business phone line, a business mobile phone, headed paper, using an accountant, sign written van, advertising, business insurance.
- Differing engagers – if self employed workers work for different engagers it will make their case stronger. This may be achievable by re-structuring working methods.
- Price work – submitting tenders for jobs and working to price, and showing evidence of this, will assist.
- Provision of loose tools and overalls.
The above points will not guarantee to protect all self employed workers status but they will tip the balance quite considerably in favour of self employment, .
What if an HMRC Status Challenge is lost?
During the course of tax enquires and reviews – either routine PAYE examinations or enquiries into tax returns – HMRC may question whether a self employed worker is really self employed (or more occasionally the opposite). This is referred to as a status challenge.
Generally this process will be one of detail, and if contacts and working practices are in place it should be resolved in your favour.
However sometimes the evidence isn’t there – contracts have not been completed, invoices haven’t been received, etc, and the case is lost. Generally this means that the Engager has to pick up the cost of tax and NI that should have been deducted under PAYE, on the basis of the wage paid being equivalent to take home pay – a process known as re-categorisation.
In short; although self employed status provides savings to both Engager and worker, the Engager is bearing a risk if it all goes wrong. This emphasises how important it is from the Engagers point of view to have contracts in place and working practices in line with those contracts.
Workers with Companies or Partnerships – IR35
Historically a the Engagers protection against Employment Status disputes was to ensure workers were engaged via a company (or occasionally a partnership).
- Pre 2000 engaging via a company was an effective protection and neither Engager nor Worker could be challenged
- Post 2000 the IR35 rules brought Employment Status into the Hypothetical Deemed Contract, which meant that although the Engager was protected, the Worker was exposed to Employment Status risks and could face a large tax bill for not assessing Employment Status correctly
- Post 2017 in the Public Sector risks arising from an incorrect status decision moved to Engagers from Workers
- From April 2021 a similar transfer of risk took place in the Private Sector if the Engager is a large or medium company (broadly turnover over £10.2m). For Engagers with turnovers beneath this, IR35 risks sit with the worker still
- See our IR35 section for more detail
There are other Employment Status news stories and comment on our site: see them all here
- Employed or self-employed? The Pimlico Plumbers ruling 04/07/2018
- P11D deadlines 31/05/2018
- Quick update: IR35 – how to calculate the deemed employment payment 06/09/2017
- Employed or self-employed? 15/03/2017
- HMRC release new Employment Status Indicator Tool 02/03/2017
- Public Sector IR35 changes – Examples 11/02/2017
- Pimlico Plumbers – and how not to do employment status 10/02/2017
- IR35 changes on hold 17/12/2015
- Employment Status 20/05/2015
- HMRC and Personal Service Obligations (updated) 11/12/2013
- HMRC and Personal Service Obligations 10/12/2013
- Autumn Statement & IR35 05/12/2013
- LATEST EMPLOYMENT TRIBUNAL RULING 02/08/2011
- ECR Consulting: IR35 Hypothetical Contracts 28/06/2011
- HMRC revision to status tests in the construction industry 21/09/2009