Employed or Self-Employed: what is the difference and why does it matter?
Posted on by Ceri John
The question of whether a worker is employed or self employed is important both to the worker and the person engaging him or her.
Tax case law has formulated “badges of trade” which are still used in determining whether employed or self employed status applies in given situations. Key factors include whether substitutes can be used, whether control is exercised and who bears the financial risk.
Currently there are two particular situations which are important with regard to the employment status of the workers concerned, namely one man limited company contractors and labour only contractors working under the construction industry rules, which the government is proposing to change.
The Intermediaries Legislation (IR35) is aimed at the situation where contractors operate through their own limited companies but are for all practical purposes employed by the end client. There may be an agency in the chain between them and the end client or they may be engaged directly by the end client. In either case HM Revenue & Customs (HMRC) will be looking to establish that a hypothetical contract exists between the end client and the contractor. There is not usually a contract drawn up between the contractor and his own company, whereas there is almost invariably a contract between the agency and the end client. The contract that HMRC will actually look at though in establishing whether a hypothetical contract exists between the end user and the contractor is the contract between the contractor’s company and the agency or the contractors company and the end client where no agency is involved.
HMRC will be looking to establish that the contract is one of service i.e. having characteristics of an employment contract. To defend his position the contractor must establish that it is one of self employment i.e. a contract for service. In order to do this the contractor must ensure that the contract includes clauses covering the following:
Control : This must demonstrate that the contractor is not under the control of the end user.
Substitution: This must demonstrate that the contractor is not required to give personal service:
Mutuality of obligation: This must demonstrate that there is no mutuality of obligation between the end client and the contractor: in other words the end user is not obliged to give the contractor work.
H M Revenue & Customs need to establish that on all three counts these clauses are contradictory or ineffective if the contract is to be caught by IR35.
The general commercial terms in the Agreement may also be relevant in determining whether the agreement is caught by IR35, if the main clauses relating to the above criteria are ineffective or omitted. Such commercial terms may include whether the contractor is obliged to provide his own professional indemnity insurance, for example. Contractors forming limited companies should be mindful of the IR35 rules before signing contracts.
The government’s proposed rules regarding determining the employment status of sub-contractors engaged in the construction industry apply similar rules to a different situation. In order for a subcontractor to be correctly classified as self-employed he must provide materials, equipment, or his own staff. In this context staff does not mean sub-contractors, only employees and equipment does not include hand tools Otherwise he will be classified as employed. Sub-contractors thinking about forming limited companies should be also careful to ensure they are genuinely self-employed as otherwise the deemed salary provisions that apply under IR35 could potentially be invoked.
Looking at the employment status indicator tool on the HMRC website it looks as though they are effectively applying the proposed construction industry rules to every situation where there may be what they call “false self-employment” so businesses need to be very careful in determining the correct status of their sub-contractors for tax purposes.
Information in this article is provided by Mr Robert Bradley.
Mr Bradley of Bradley & Associates (www.bradleyandassociates.co.uk) is an accountant based in the heart of Worcestershire and a member of the BIRR Accountancy Partnership Programme.
If you are looking for an accountancy firm who are genuine business advisers in the Worcestershire area get in touch with Bradley & Associates now.
Categories: Accountancy