Employed or self employed? - that is the question
Updated: Feb 7
Are you employed or self employed?
Many people believe that they are free to decide whether to be employed or self employed. There can be advantages and disadvantages to both parties in the relationship, other than taxation. This article focuses primarily on the taxation issues.
For the self-employed business person, classifying themselves as self employed will save them National Insurance, as they pay 9% Class 4 rather than 12% Class 1 National Insurance contributions. For the person paying for the work, whether as employer or contractor, it would avoid them having to pay employer’s National Insurance at 13.8% on top of the agree price should there be a self-employed relationship between the parties.
However, a person providing their services to a third party may wish to be classified as an employee. This would provide entitlement to sick pay, redundancy pay, the right not to be unfairly dismissed, rights under health and safety and employment laws and also more recently to be automatically enrolled into a work place pension scheme.
Both case law and H M Revenue & Customs emphasises that the two parties cannot decided to be self employed or employed for their own convenience. However, if the contractual and actual relationship between the parties is set up correctly then the parties can decide. Deciding whether someone is employed or self employed is not as straightforward as it might at first appear. Simply drafting a contract between the two parties stating the desired relationship will not work, unless the actual facts of the case show that agreed relationship.
How do you decide?
The simple answer is to look at the actually facts of the case and compare those facts with established practice and case law. There is not always a clear-cut answer to this question. H M Revenue & Customs published a leaflet (ES/FSI employed or self employed for tax and national insurance contributions), which sets out a series of questions to test the particular circumstances of any working relationship. It should be emphasised that this is H M Revenue & Customs’ own leaflet and whilst is sets out established case law, it is not for H M Revenue & Customs to decide if there is an employment or self employed relationship. It is for the legal system i.e. courts and tribunals to consider all the facts and make a decision.
The following matters should be considered:-
Right of substitution. Can you send another person to do the job?
Mutuality of obligations. Does one party have to provide work and the other have to accept it, or are you free to reject worked offered?
The ultimate control of the work.
Can a person profit or risk making a loss from their work?
Who provides the materials and equipment?
How integrated is the person within the employer's business, e.g. do they attend Christmas parties, and training days? What is their job title Director, Manager or contractor?
The intended relationship between the parties. Whilst not hugely important, it can help sway the decision.
The general working patterns and relationships for the commercial sector.
As I have noted above, the points are legal criteria built up over many years by case law. They are matters of general employment law and not specifically determined by any tax law.
It may be tempting to cut payroll costs (i.e. National Insurance) by taking on previous employees as self-employed contractors. However, there are risks in using this strategy. But if done correctly it can provide a tax efficient method of cutting costs.
To strength the self-employment case, the following should be considered:-
The engager is not obliged to use that worker's services; and
The engager does not have the right to control what the worker does.
The worker may provide a substitute and the contract allows this.
The worker is not required to work for a particular engager.
The worker operates a business assuming risks such as rectifying work, invoicing and waiting for payment.
H M Revenue & Customs have developed their Employment Status Indicator which is a series of questions, based on a points system, to help determine the true legal nature of a working relationship.
Businesses that try to hide their actual working relationship by inserting a limited company between the employer and the employee will be caught by the IR35 legislation. This will ignore the legal structure in place and require the employee, via the limited company, to calculate and account for the income tax and National Insurance as if there was a direct employer-employee relationship. It is the limited company that must pay both the employee’s and employer’s National Insurance.
Many a larger business will encourage an independent worker to set up a limited company to administer the relationship between the two parties. However, it is the worker that will lose out if there is a real employer/employee relationship in that the latter will pay all the employer’s National Insurance.
Self-employed workers are taxed under self assessment by completion of a Tax Return. They are able to claim more in expenses. They also must pay Class 2 and Class 4 National Insurance, but this is still less than the Class 1 National Insurance paid by employees.
It is not surprising, therefore, that many businesses ‘choose’ to be self employed and in fact, many an employer will encourage their workers in that direction.
What happens if you get things wrong?
It is normally the responsibility of the person making the payment to get it right. If they treat a worker as self employed and the worker is later determined to be an employee, then it is normally the payer that must fund any shortfall in tax. This can leave the worker with income that is determined to be net of tax with no further tax to pay, when the intended relationship was that this was their gross income which would have been subject to tax and National Insurance.
As usual, H M Revenue & Customs will be quick to want to charge interest and penalties.
Creating the image of self-employment
A proper drawn up contract dealing with the services to be provided and setting out the relationship can be a powerful tool in defending a challenge by H M Revenue & Customs. Even in grey cases, the contract and actual paperwork on a day to day basis can really help. The following are matters to consider:-
Provision of equipment
It helps to demonstrate the case for self-employment if the worker supplies at least some of the main equipment or tools. Of course, the extent to which equipment is required depends upon the nature of the work.
Self-employed people should be seen to bear an element of risk, in that they can make a loss as well as a profit from their work. Charging a price for the job rather than per hour helps to demonstrate this principle. The important factor is to agree and document a price or at least a method or formulae for charging for each piece of work before the job commences. This helps to show that the worker can benefit from quality work or working harder and smarter.
Quality of work
The more freedom that the worker has in how and when they perform their work the better. It should be clear from the outset that the worker will have to put right any faulty work at their own expense.
One of the strongest tests of self-employment is the right to send a substitute instead of the worker. The case is even stronger if the worker has a substitute lined up and occasional uses a substitute. Self-employed people tend to have their own liability insurance in place if things go wrong.
Is the construction industry different?
No, whilst the construction industry may deal with the payment of taxes different for its workers, it must firstly determine the employment status of all its workers before any special rules are dealt with that are specific to the construction industry. There are some special considerations.
Popular to belief, registration as a subcontractor within the construction industry scheme does not prove the worker is self-employed.
Where the work requires expensive or heavy plant and equipment, it can help to show a self-employment relationship if the worker hires the equipment, even from the company providing the work to the worker. The worker would then charge more for the job, but have to also pay for their equipment. Such arrangements may seem a little artificial but the more that is done ‘to set out your stall’ correctly, the better.