Most businesses have employees, and most have other people who work for them but are not treated as employees.
The distinction between an employee and a self-employed person is often obvious, but there can be problems in borderline cases.
Why does the difference between employed and self employed matter?
HMRC are stepping up their programme of “Status Reviews”. A Status Review involves looking at the contractual relationship between the person doing the work and the person paying for it, to determine whether an employment exists. The consequences can be serious if you have been treating someone as self-employed and the Status Review determines he is in fact an employee. HMRC will expect the employer to pay the income tax and National Insurance Contributions that should have been deducted under the PAYE system, together with the Employer’s NIC contributions.
In many cases, neither the worker nor the person paying him want to have an employer/employee relationship – indeed, in many cases I have seen, it would be impossible for the business to get the work done if it had to be done by employees. In these circumstances, it is important to ensure that the way the agreement is structured will survive a Status Review, and what follows are some basic pointers to the things to consider.
The Difference Between Employment and Self-Employment
Like so much in tax, the basic proposition looks deceptively simple:
- An employee is hired under a “contract of service” (better known as an employment contract)
- A self-employed person agrees a “contract for services” with you – he is in business on his own account, with the risks and rewards that implies
The problem is that in many cases, it is not immediately clear which side of the line a particular engagement falls. When they conduct a Status Review, these are the things HMRC will look at:
Does the employment contract reflect the business relationship?
A contract need not be in writing, and a written one will only be valid if it reflects the reality of the arrangement. If, however, there is a written contract that truly reflects the business relationship, and that contract points to self employment, that may be the end of the matter – so always have a written contract with someone who you treat as self-employed.
Control of the employee
An employer has more control over an employee than he does over a self-employed contractor. Within reason, an employee can be asked to do anything his employer wishes, so for example if he has finished his normal work, he might be asked to take some letters to the post, or tidy the stationery cupboard, or whatever. A self-employed person does what he has agreed to do and nothing else – if I am at your office advising you on tax, I will not tidy your stationery cupboard, however nicely you ask me! – the more flexible the worker is about what duties he will perform, the more likely he is to be employed.
Financial risks and rewards of employment vs self-employment
Some employees may get bonuses or other rewards, but it is the very nature of self-employment that you risk your own capital (by buying equipment, renting office space, and so on) and profit from managing your business efficiently (if I give a fixed quote for a piece of tax advice, and finish it in less time than I expected, I have made an extra profit). The downside is that if things go wrong, the self-employed person will generally have to put them right in his own time and at his own expense – the absence of this risk/reward balance suggests an employment contract is involved.
Pay and benefits for employment
Employees are generally paid by the hour, week, or month. If they work longer hours, they may get overtime, and they get such benefits as holiday pay, sick pay, maternity pay, and so on. None of this applies to a self-employed person.
Having said that, some self-employed persons charge by the hour – I do, in many cases – and this illustrates an important point about all these categories – they are all indications rather than conclusive tests, and it is the combination of all the factors that will give the answer as to the status of the business relationship.
How closely is the worker associated with the organisation
The more closely the worker concerned is identified with the organisation he works for, the more likely it is that he is an employee – such things as business cards with the company logo, uniforms, and name badges are all characteristic of employees. A real example from my days as an Inspector of Taxes is that of a receptionist/telephonist who it was claimed was self-employed – but she was in fact an employee on the basis of this test, as she was the “public face” of the business concerned – the first point of contact for members of the public coming to the office.
Provision of Equipment
Be careful with this one – in many trades it is customary for employees to provide small items of equipment for themselves (I bought my own calculator when I worked for the Big 4!). The test becomes relevant when major items are involved – a taxi driver who owns his own cab is almost certainly self-employed.
Delegation of work can signify self-employment
This is perhaps the only test that is likely to be conclusive in favour of self-employed status, but for that very reason it has caused a lot of problems because it is imperfectly understood.
An employee contracts to provide his own personal services – he cannot decide to send a substitute if he does not feel like turning up for work. A self-employed person, on the other hand, is normally free to have the work he has contracted to do done by someone else, whom he pays.
All the bar staff at my local pub are (I assume!) employees. If one of them (Brendan) fancies a night off, he can speak to the pub landlord and suggest that his friend Joe fills in for him. If the landlord agrees, then Joe will work the shift and the landlord will pay him. This is not delegation, for two reasons:
- Brendan needed the landlord’s agreement for Joe to take his place
- The contract that night was between the landlord and Joe, not between Brendan and Joe
Genuine delegation means that the self-employed person gets someone else to do the work, and he pays him and is responsible for his doing a decent job – if this sort of power to delegate genuinely exists, it is highly likely that the person concerned is self-employed.
Special employment vs self-employment cases
In most cases, employment status is decided on the basis of the above factors, but there are a few special cases where the law prescribes whether a person is employed or self-employed (and just to make it even more difficult to comply with the rules, in some cases the law requires different treatment for income tax and for National Insurance Contributions). These are too numerous and complicated to mention here, but there is one specific point to be aware of:
Construction Industry Scheme for self-employed contractors
This is a scheme for deducting tax from payments made to subcontractors in the construction industry – see the June 2006 Tax Insider for more details – but it must be remembered that the CIS only applies to self-employed subcontractors, so before you operate the CIS you must first look at the tests above and satisfy yourself that the sub-contractor is not in fact an employee.
Get a status ruling to determine employment vs self-employment
It is possible to ask your local tax inspector for a ruling on whether a particular individual is employed or self-employed, and HMRC have an electronic “Employment Status Indicator” on their website (though last time I looked it wasn’t working). This may be the answer in some circumstances, but you will not be surprised to learn that in cases of doubt the inspector is likely to rule for “employed” rather than “self-employed” – if it is commercially essential that the relationship is not one of employer/employee, it is better to take expert advice on the terms of the contract, and only then to consider whether to apply for a status ruling or not.
First published February 2007.