Employed or Self Employed?
The question as to whether someone is employed or self employed is not as straightforward as it might at first appear. Most people take it for granted that they are free to choose, but HM Revenue & Customs emphasises that this is not the case.
How do you decide?
The answer to this question is a matter of general employment law, and not specific tax legislation. There is no clear-cut answer to this question, the factors that will be taken into consideration in determining a workers status cover areas such as:
- Ultimate control of the work. A self-employed person should exercise independent control and judgement over how the work is carried out i.e. the means and methods
- Working for a number of people. The greater the number of client’s the more indicative of self –employment status. Working exclusively for one organisation is indicative of employment.
- Profit element, and risk of loss.
- Self-employed individuals usually have the right to appoint a substitute or to delegate work to others and are not necessarily required to carryout work personally
- Mutuality of obligations. A self-employed worker is not obligated to accept new work assignments from the work provider and the work provider is not obligated to offer new work assignments
- Correction of faulty work at own cost and time
- Provision of own materials and equipment
- Working hours. Generally the self-employed have greater freedom to negotiate their working hours and working practices
- Integration with the employer's business. Self-employed individuals are not generally integrated into the organisational structure of the work provider
- The intention between the parties
- Usual conditions in the industry
HM Revenue & Customs are not always unbiased in their assessment of self-employment status and their interpretation of case law. They often place emphasis on reclassifying individuals claiming to be self-employed. HMRC have published two leaflets (ES/FS1 Employed or self-employed for tax and National Insurance contributions and ES/FS2 Are your workers employed or self-employed for tax and National Insurance contributions). [links to PDF documents] which set out a series of questions to test the particular circumstances of any working relationship.
What are the practical differences?
Employees are taxed under the PAYE system and are liable to Class 1 national insurance (NI) contributions. If the worker is an employee, the employer also has to pay Class 1 NI – over a limit set each year, the employee's NI rate reduces to 2%, but for employers NI continues at the full rate, with no upper limit. The employer also assumes responsibility for paying Statutory Sick Pay and Statutory Maternity, Adoption or Paternity Pay.
Employees have rights under health and safety and employment laws, such as the rights to redundancy payments and not to be unfairly dismissed. Moreover, the range of social security benefits is greater for employees than for the self employed.
Self employed workers are taxed under self assessment, and are allowed more scope in claiming expenses. They also pay Class 2 and Class 4 NI contributions, the combined burden of which is lower than Class 1 NI. Their 'employers' are not subject to NI.
It is not surprising, therefore, that many businesses show a marked preference for self employment status for their workers!
What if you are wrong?
It is the responsibility of the person making the payment to get it right. If you treat a worker as self employed and he or she is subsequently ruled to be an employee, you could find that all the payments you have made will be treated as net payments, and you will have to pay the corresponding tax and employees' NI, as well as the employer's NI. You have no right in law to recover such items from your employees after the event. In rare circumstances that HMRC cannot recover from the person making the payment they may seek recovery of additional taxes and NI from the worker.
You may also have to pay interest and penalties for incorrect returns.
Can you create conditions to favour self employment?
If you want to substantiate a classification of a worker as self employed, we strongly recommend that you have drawn up and enforce a suitable contract defining the services provided. In line with the tests referred to above, you will need to give particular consideration to the following points:
Risk and Reward
One of the main requirements is that self employed workers bear some element of risk in the arrangement. Whenever possible this is best demonstrated where work is undertaken on the basis of a “price for the Job”. Ideally the price, scope, and timing of the work should be agreed, and evidenced in writing, before the job commences.
Control
Self employed workers should exercise a significant degree of independent control over how they organise and carryout their work
Workmanship
Within reason, the more freedom the worker has in the detail of the way the work is carried out the better. You must also make it clear that the worker will have to put right any faulty work at his or her own expense.
Substitution
One of the strongest tests of self employment is the right to substitute a worker who is equally capable of carrying out the work.
Insurance
All self employed workers should hold public liability insurance and preferably professional indemnity insurance
Provision of equipment
Where practical, the worker should supply at least some of the important equipment or tools. Of course, the extent to which equipment is required depends upon the nature of the work.
What about the construction industry?
The construction industry is subject to exactly the same rules as any other type of industry. However, there are some special considerations.
Where the work entails use of heavy equipment or expensive plant, it is sometimes recommended that contractors hire the equipment to their subcontractors, who then include the cost within their 'price for the job'. Such arrangements may seem artificial, and there is the danger that with substantial hire costs being included in the pricing, the subcontractor's turnover may breach the VAT threshold and force him or her to register for VAT. However, this is not necessarily a bad thing because VAT registration is often cited as further evidence of self employment.
With regard to pricing work, a competitive tender is best, but in practice it should not really matter who makes the first suggestion of an appropriate price.
Although there is a special scheme for taxing construction industry workers, the fact that a subcontractor is registered does not, in itself, necessarily prove self employment status.
Workers who invoice for labour and materials are more likely to be viewed as Self-employed.
What about personal service companies?
These guidelines apply equally to the so called 'IR35' rules to test whether a worker would be treated as an employee of the client, if it were not for the existence of an intermediate service company. There are further rules for "Managed Service Companies".
[link to Contractors and IR35 internal page. This is one of Websmiths own content pages]
