Ensuring that an individual understands the significance of their Employment Status is important for many reasons, not least in understanding how they will be taxed on their earnings and any requirement to make assessments with HMRC.
This can be a complex area however; this article has been prepared to give an overview of some of the key considerations.
First of all, dealing with terminology, a contract of services is that of an employee-employer and a contract for services is that of a contractor-client.
Additionally, the rules known as IR35 apply when an individual is providing their services through their own Limited Company. IR35 is essentially in place to address the issue, if it were not for the Limited Company that sits between the individual and the end organisation, could the relationship between them be viewed as one of employee and employer.
A whole host of factors are considered, those key ones are listed below and are equally relevant to considering the status of a contractor who is self-employed but is not operating through a Limited Company:
- Supervision, direction and control over work
- Right of substitution
- Mutuality of obligation
- Use of equipment/provision of tools
- Financial risk
- Length of engagement
- Opportunity to profit
- Part and parcel
- Quality over quantity/ matter of fact
If found to be ‘in-side’ of IR35 then that contract should be taxed ‘on-payroll’ and subject to Income Tax and Class 1 National Insurance through PAYE. What is important to note is that this does not necessarily mean that the individual will then accrue general employment rights and benefits, they are merely being taxed on payroll, and will often be referred to as a deemed employee for tax and usually the end client will operate a separate payroll from its genuine employees in such situations.
In operating your business through a Limited Company and considering IR35, it’s important to understand where the responsibility sits. For those providing services through a Limited Company to an organization which sits in the Public Sector, it is the Public Sector Body who, since 6 April 2017, has had responsibility to determine the IR35 position of its workforce. Similar measures are set to come in across the private sector, delayed in April 2020, but the responsibility will only be moved to larger organizations. Therefore, an individual providing services through a Limited Company to Private Sector organization is currently responsible for assessing its IR35 status and even when the changes come into the Private Sector, they may continue to be responsible. They will therefore need to take greater interest whether their end clients may start to take on this responsibility in the future.
In many cases where individuals have contracts that fall within IR35, they may be looking to assess the benefit of continuing to work through a Limited Company.
Where an individual has responsibility to assess if their contract falls within IR35 and it does, there is a specific way they need to ensure this income is taxed and most significantly it means there is minimal expenditure that can be offset, as would be the case if they were employed.
Moving on to an individual who does not operate through a Limited Company, and believe they are operating as a sole trader and thus self-employed, in all cases it is the end client’s responsibility to assess the individual’s position, and due to recent case law, there are three main types of employment status:
There are still only two status from a tax point of view; employee or self-employed but if you are a worker you are deemed to be taxed like a self-employed individual but you do accrue some employment rights. This was highlighted in the 2018 case of the business Pimlico Plumbers.
Therefore, we currently have a mis-match between law and tax which over time may be aligned.
In light of all of this, the detail within both a contract and the working practices of how someone undertakes their work are therefore key to fully assess the status of an individual’s employment status.
Looking at the list of key factors, what the rules are there to determine is; do we have someone akin to that of an employee, do they have set working hours, they are supervised and appraised, provided with equipment and the contracts sets a clear requirement to provide work and undertake the work without substitution, for a considerable length of time. Alternatively, do we have someone taking financial risk, working for many other businesses, managing their time and working hours and when and where these are undertaken, with the provision of their own equipment.
From a Tax perspective, those who are fully fledged employees or taxed as deemed employees have limited expenditure they can offset against that income and are subject to Income Tax and Class 1 National Insurance on it.
Those who are operating through a Limited Company can offset any expenditure that has been wholly and exclusively incurred in delivering the services and those sole traders and partnerships can offset the business element of any expenditure incurred in delivering the contract, thus reducing their taxable profits. Those operating via a Company are subject to corporation tax on the profits in the Company and then need to consider the Income Tax on extracting this, and those sole traders are subject to Income Tax and Class 2 and 4 National Insurance on the profits made in the year.
Therefore, dependent on the level of profit an individual anticipates making, they would also want to weigh up the pros and cons of operating as a sole trader versus a Limited Company.
This is a complex area of legislation, HMRC guidelines and case law and the approach the Government has taken with the varying Covid-19 support measures only reinforces this. Additionally, with many employees now working from home they will no doubt wish to better understand the expenditure they can claim to cover the costs of home working and there will inevitably be a surge of revisions to contracts to reflect new working arrangements.
It is therefore important to understand the status of how a contract will be performed, before it is entered into and to seek advice. If HMRC were to ever challenge a decision in the future it would always be beneficial to evidence a duty of care has been undertaken in trying ensure your contract is taxed in the correct way.