As part of an “Employer Compliance Review”, it is standard practice for the HMRC officer to look out for individuals being paid on a self-employed basis and try to get them reclassified as employees. This is done by referring the case to a “Status Inspector”, who specialises in the distinction between employed and self employed status.
If someone who has been working on a self-employed basis is reclassified by HM Revenue & Customs as an employee, this can be very bad news for the person they have been working for. The ‘employer’ will have to find additional tax and NIC, probably for the preceding 5 (or sometimes more) years. This is calculated on a ‘grossed up’ basis, which makes things even more expensive. For every £100 actually paid, the tax and NIC is calculated on the basis of the amount of salary that would have been needed to put £100 in an employee’s pocket after deducting the PAYE due. The result is that for every £100 paid out, the employer is likely to have to find between £35 and £50, depending on the precise circumstances.
Until recently, there was a further problem in that any tax and NIC paid by the individual concerned on a self-employed basis would be repaid to them if they were reclassified as an employee, so that the employer had to find the whole of the tax and NIC involved by himself. Since April 2008 an amendment to the PAYE regulations means that tax paid by the erstwhile self employed individual under self assessment can usually be set off against the tax payable by the employer.
There is no formal legal definition of the distinction between employment and self-employment - it is a matter of interpretation. Unfortunately, HMRC have a tendency to overcomplicate matters by looking at every detail of the business relationship concerned as if they were using a pair of scales with ‘employed’ on one side and ‘self-employed’ on the other – not surprisingly, the ‘employed’ side seems to have the greater load in most HMRC rulings!
The reality (which HMRC will usually reluctantly concede if it is put to them properly) is that in a case where both parties to the arrangement have decided that they want it to be one of self-employment, if HMRC want to overturn this and treat it as an employment there is a very limited number of crucial factors which must be present if they are to succeed. Essentially, there are three key factors, and if any one of them is not present, and the worker and the person he works for both agree that the business relationship is one of self employment, then there is no employment.
The relationship between an employer and his employee has been rather quaintly described in the Courts as a “master/servant relationship”. An employer can tell his employee what to do, how to do it, where to do it, and when to do it. A self employed individual, by contrast, agrees to get the job done, but the details are up to him.
This can become problematic in a case where the individual concerned works on the client’s premises, as in such cases he will need to fit in with such matters as office opening hours, health and safety rules, security arrangements, and so on. These are things dictated by the nature of the work to be done, not by the commercial relationship between the employer and the employee, but HMRC will sometimes argue that they are characteristic of a “master/servant” relationship.
Another aspect of the “master/servant” relationship is the existence of mutual obligations. Put simply, the employee has an obligation to turn up for work, and when he gets there, the employer has an obligation to give him work to do, or at least to pay him for his time. In the case of a self employed contractor, he can decide when and if he turns up (though if he wants to keep the client he will do his best to be obliging about this!), and if there is no work for him to do, the contractor has no obligation to offer him any, or to pay him.
This is another essential for an employment to exist, and unfortunately it has been much misunderstood by both sides.
A contract of employment demands that the employee himself performs the duties of the job, and he cannot send a substitute. If the arrangement with the client genuinely allows for another person to be sent, at the expense of the self employed contractor, to perform the work concerned, then it cannot be said that the contractor is an employee.
Those who claim to produce “HMRC proof” contracts for self employment can sometimes rely too heavily on this aspect, and include a clause in the contract saying that the contractor has the right to send a substitute to perform the duties. Too often, these arrangements are shams and in fact the substitution never happens and never would happen. The Courts, while affirming the significance of a genuine right of substitution, have also made it clear that a mere clause in a contract is not enough if the reality of the situation is different.
It is often the case that the contract gives the client the right of veto over the person sent as a substitute, and this is not a problem where the veto is reasonable, based on suitable experience or qualifications.
The important point is that the contractor must be responsible for selecting a suitable substitute, and for paying him. It is no good merely recommending someone to take over while you are off sick or on holiday, and the client paying that individual directly.
Not in Business
This is a negative definition, because if it can be shown that the contractor is genuinely “in business on his own account” and the work concerned is being done as part of that business, then he is not an employee when he does that work.
In some cases, it is obvious that someone is in business on his own account – typically where he has a significant investment in plant and machinery which he uses to provide the services concerned, or uses his own employees to assist him. There is more of a problem in a case where it is either the brains or the brawn of the individual that he uses to do the work, and there is either no plant or machinery involved in the work, or what there is belongs to the client.
Another factor here is economic risk – but this is often overplayed by HMRC, particularly in a case where the work is charged and paid for by the hour or by the day. They will argue that in such a case the worker has no risk, in contrast to someone who quotes for the whole job and can then be either in or out of pocket depending on how long it takes him to complete the work. The mere fact that the payment for the job is based on an hourly rate is not conclusive either way. In a genuinely self employed situation, however, there will usually also be an agreement as to how long the job will take, or an obligation on the contractor to remedy errors in his own time.
Smoke and Mirrors
In any case where the contractor and the client have thought about their business relationship and decided that they both want it to be one of self employment, the above factors must ALL be present if HMRC are to interfere and reclassify the relationship as an employment, but the approach taken by Status Inspectors seldom acknowledges this. They prefer to claim that the whole question is somehow a matter of overall impressions and balancing the points for and against in order to reach a balanced view.
They will claim that their role is to reach an objective conclusion based on the facts, but this is mere spin – if you doubt it, ask them how many employees they have reclassified as self employed!
The answer will be “none”. This is not surprising, because if both parties to the arrangement agree between themselves that it is an employment, then that settles the matter. Unfortunately, HMRC do not accept that this applies in the case of self employment. A Status Inspector, therefore, only ever looks into cases where the parties concerned have decided that they want a self employed arrangement, and then only to see if he can find grounds to force employment status on the parties concerned. So much for objectivity!
If HMRC try to reclassify you or someone who works for you as an employee, or if you are concerned that they might try to do so, it pays to seek specialist advice. Too many people are bamboozled by HMRC’s arguments and concede employment status when a vigorous defence would have been successful, or some small alterations in the contractual relationship could have prevented the argument in the first place!