Employed or Self-Employed – a question of Status In some of my more recent articles for Tolley’s Practical NIC Newsletter (Incorporation Again – July 2007; HMRC’s School Rules – October 2007; Employment status, Demibourne and NIC– July 2008) I have referred to the question of determination of whether an individual is employed or self-employed, ie, the “status” question. Although most status questions are instigated by Inspectors of Taxes, who consider it to be pertinent to taxation, the majority of potential additional liabilities are National Insurance Contributions rather than Income Tax. This is because many expenses from income are relievable for tax purposes no matter whether the individual is employed or self-employed. Whereas, on the other hand, there can be considerable impact on NIC depending on the status, or categorisation, of the individual concerned. This is borne out by the simple example below.
Employed v Self Employed (2007/08) – Income Tax Employed
SelfEmployed £ 41,500
£ Turnover Salary and expenses Expenses: Business Travel and subsistence Administration costs Accountancy Net Taxable income
41,500 1,500
1,500 500 1,000
40,000
38,000
Without doing the actual calculations for tax, you can see that the differential is only £2,000 at 22%, ie, £440. Even if we were into higher rates of tax the amount at stake is only £800 for this example. Yes, I know that the liabilities increase substantially for larger amounts and, yes, extrapolation over a number of years increases the liability still further. However, sticking with one year for the moment, let us see the impact for NIC purposes in the following example.
Employed v Self Employed (2007/08) – National Insurance Contributions £ Employed Earnings Employee’s NIC (Upper limit) Less lower limit Class 1 (40,000 – 34,840)
34,840 5,225 29,615
£ 40,000 x 11% x 1%
£
3,257.65 51.60 3,309.25
Employer’s NIC (No Upper limit) Less lower limit
40,000 5,225 34,775
x 12.8%
Total NIC for an employee Self Employed Earnings Class 2 Class 4 (34,840 – 5,225) Class 4 (40,000 – 34,840)
4,451.20 £7,760.45
40,000 52 x £2.20 x 8% x 1%
114.40 2,369.20 51.60 £2,535.20
So, we have a potential Income Tax liability of, say, £440 compared with a potential NIC liability of £5,225.25 (Ie, £7,760.45 less £2,535.20). As a contractor/employer, I know which of these liabilities I would be most concerned about! In addition to the above, we also need to remind ourselves who will suffer any additional liabilities found to be due once the Revenue have undertaken a status review. It is the deemed employer who foots the bill and who, generally, cannot obtain recompense from the individual concerned. In my last article for Tolley’s Practical NIC Newsletter (July 2008) I covered the implications of the Demibourne Review and revised legislation, and the circumstances under which deemed employers could obtain credit for Tax/NIC paid by individuals previously treated as self-employed. This is usually the only way a deemed employer will be able to reduce additional liabilities found to be due. Determination of Status So we now have the attention of those businesses and organisations who may ultimately bear the price of engaging an individual in a self-employed capacity who is, subsequently, determined to be an employee. How do we make the distinction between the two categories? As indicated previously by myself and other contributors, determining status is undertaken using a mixture of Statutes, Case Law and practice/experience. Unfortunately for tax practitioners, the Statutes are of limited use (although of more use for NIC purposes for certain types of work, for example, those in the teaching profession) and most status issues boil down to Case Law and practice/experience. The Revenue, helpfully, also provides an amount of guidance material concerning status including a relatively new online “interactive” calculator called the “Employment Status Indicator”. Interestingly, the Revenue’s guidance is in its “Employment Status” manual, which suggests to me that the Revenue tend to review income from an employment position first rather than from a neutral position. However, I believe that this is probably understandable in the Revenue’s position. Clearly, this article is not going to consider all the intricate details and aspects of the myriad clauses, cases and articles that have been produced over many years, and I intend to merely provide a brief overview of the factors used by status Inspectors
and professional practitioners to aid in determining the correct position in a status case. The Revenue, again helpfully, provide a leaflet, IR56, which includes a brief summary of the factors that it thought important. However, that leaflet was last updated in July 2004 and readers are encouraged to seek advice from the Revenue website. The basic guidance is, according to the Revenue, down to considering 13 questions. If you can answer yes to ALL the first five questions, then you are PROBABLY an employee, whereas if you can answer yes to ALL the remaining 7 questions, you are USUALLY self-employed. The questions are as indicated below. 1. Do you have to do the work yourself? 2. Can someone tell you at any time what to do, where to carry out the work or when and how to do it? 3. Do you work a set amount of hours? 4. Can someone move you from task to task? 5. Are you paid by the hour, week, or month? 6. Can you get overtime pay or bonus payment? 7. Can you hire someone to do the work for you or engage helpers at your own expense? 8. Do you risk your own money? 9. Do you provide the main items of equipment you need to do your job, not just the small tools many employees provide for themselves? 10. Do you agree to do a job for a fixed price regardless of how long the job may take? 11. Can you decide what work to do, how and when to do the work and where to provide the services? 12. Do you regularly work for a number of different people? 13. Do you have to correct unsatisfactory work in your own time and at your own expense? If only it were as easy as this suggests! Even if you were able to answer no to the first five questions and yes to the remainder, the Revenue only go as far as saying that you are usually self-employed. For many contractors and individuals, the truth will be a mixture of answers but you cannot merely add up those for and against to come out with the answer. One of the things that the questions do not provide is weight. For example, the fact that somebody is paid by the hour may not carry as much weight as having to correct unsatisfactory work. The questions themselves provide ambiguity; for example, I can see a difference between overtime pay (generally employment related) and bonus payments (potentially contractual completion bonuses) in question 6. Also, in question 13, does it make a difference if you have to correct the work in your own time but charge for the expenses? Also, how many accountants and tax advisors would get caught out by question 10 (fixed pricing)?
Other questions do not necessarily take into full account of the commerciality of the job, or other legislative obligations, for example, under Health and Safety Regulations. An example of commerciality might be building contractors providing materials because they can reduce the cost due to VAT and, command a better deal from the suppliers. Similarly, other obligations might be imposed under Health and Safety Regulations not allowing individuals to work on particular sites beyond certain hours. Neutrality and ambiguity are often seen by the Revenue as being irrelevant. However, they are as much a part of the decision making process as any other, more obvious, answer. On their own, the questions are insufficient to determine status but, collectively, they may give an indication of what the status might be. This is where practice and experience is likely to come into the equation. Particularly as there have been instances where the answers to the above questions would suggest that the individual is an employee. A particular case is O'Kelly and Others v Trusthouse Forte plc [1984] 1QB90 which concerned a number of regular casual catering staff. Predominantly, the indicators, or factors, pointed towards employment status but the deciding factor was not one that even appeared on the Revenue’s list of questions. Mutuality of Obligations and other factors The judgement came down to the fact that the hotel was under no obligation to offer work to any one of the regular casuals. In addition, when the casuals were asked to work, there was no obligation on their part to accept. This lack of “mutuality of obligation” is an extremely important factor in status cases. However, it is not necessarily a point that the Revenue will easily concede. Other factors which can decide a status issue include the right of substitution. As it implies, it is the right to provide a substitute that is important, not that a substitute has been provided to date. However, the Revenue will look very closely at any case that hinges on substitution and will insist that there must be a “genuine” right of substitution before allowing the point to rest. Genuine substitution is clearly easy to demonstrate if, in fact, substitution has actually occurred. However, in other circumstances, the substitution clauses must confirm that appropriate substitution can occur. This allows for stipulations to exclude unqualified or inexperienced substitutes but the more exclusions made, the more likely it is that the Revenue will challenge the right to substitution. A particularly important factor could be the number of clients that the service provider has. Most commentators and advisors would not be too concerned advising individuals who have, say, a dozen clients but there is really no safe number. The Revenue can, and do, attack situations where there are a number of contracts but, predominantly, earnings come from one particular client. In those circumstances, the individual may well be self-employed for most of the contracts but employed for one of them. The final thing is I want to mention here is that it is important to document the arrangements in writing. Although a contract can be oral, implied or written, the written word is the most powerful tool available in any status issue. I have never
been a fan of “Status proof� contracts, but always recommend that a contract fully details the terms and conditions under which work is to be carried out. However, it is important to ensure that the contract accurately reflects those terms and conditions as, otherwise, it may not be worth the paper that it is written on. Summary Status enquiries will occur on a regular basis, and the Revenue has a wealth of knowledge and experience available to it. Most offices have a Status Inspector who deals with all status matters for that office. S/he has access to all other Status Inspectors and can, therefore, be constantly up to date with current trends potentially affecting status matters. Accordingly, it is important to be prepared for an enquiry and, if necessary, take advice from an experienced advisor. Ken Voller FFTA ATT is a tax and business adviser and can be contacted by telephone on 023 8090 6534 or by e-mail: ken@tax-business.co.uk