CHAPTER 28 EMPLOYED OR SELF EMPLOYED?

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1 CHAPTER 28 EMPLOYED OR SELF EMPLOYED? In this chapter you will learn about the distinction between employed and self-employed workers including: why the distinction matters; the criteria for determining the status of a worker; a selection of cases in this area Introduction The tax legislation does not tell us whether a worker is employed or self-employed, so the distinction between the two is based on HMRC practice and case law. In the majority of instances it is obvious whether an individual is an employee or whether he is in business on his own account as a self-employed trader. However there is a considerable grey area between the two. Responsibility for correctly determining whether an individual is employed or selfemployed rests with the business which engages the services of the worker (the engager ). In cases of doubt, an engager who is taking on the services of an individual can ask their local HMRC Status Inspector for an opinion as to the employment status of the worker. Alternatively the engager can obtain an HMRC view of the employment status of a worker by using the Employment Status Indicator (ESI) tool on the HMRC website. Provided the answers given to the ESI questions accurately reflect the terms and conditions under which the services are provided, HMRC will be bound by the ESI outcome Employed or self-employed Why does it matter? A worker's employment status ie, whether they are employed or self-employed - is not a matter of choice. Whether someone is employed or self-employed depends upon the terms and conditions of the relevant engagement. It is important to determine correctly the status of a worker because the tax and NIC treatment of workers who are employees and workers who are self-employed are different. An incorrect classification of a worker s status will therefore mean that the amount of tax and NICs paid is incorrect and the tax and NICs are paid at the wrong time. It is also unfair that two workers engaged by separate businesses on similar projects who perform the same tasks and receive the same pay do not pay the same tax and NIC because of the incorrect classification of one of them. Illustration 1 Lilliput Ltd engages the services of Derek as a handyman on 6 April Reed Elsevier UK Ltd FA 2015

2 Derek informed Lilliput Ltd that he is self employed. He invoices Lilliput Ltd at the end of each month and is paid gross, without deduction of tax or NICs. From his gross payments, Derek deducts the costs of travelling to work every day along with some other expenses such as stationery and clothing. Derek accounts for tax and NICs on his business profits via his annual self assessment tax return. An HMRC enquiry into Lilliput Ltd s PAYE procedures in 2016/17 results in Derek being reclassified as an employee from his first day of work. As a result: Income tax should have been deducted at source from payments to Derek under PAYE (rather than being paid on the following 31 January under self assessment); Class 1 primary NICs should have been deducted from payments to Derek (rather than Class 4 and Class 2 NICs being paid on the following 31 January); Additional NICs will be due as the Class 1 rate is higher than the Class 4 rate; Class 1 secondary NICs should have been paid by Lilliput Ltd on payments to Derek; Derek should not have made payments on account under self-assessment as most of his tax liability should have been paid at source; The expenses deducted by Derek from his income will not be allowable. For example, home to work travel costs are not deductible and it is unlikely that Derek will be allowed a deduction for stationery and clothing as these will not meet the wholly, exclusively and necessarily tests which apply to employees; Derek may have registered for VAT as a self employed individual. His registration will need to be cancelled and any VAT paid or repaid will need to be revisited; As an employee, Derek will receive protection under Employment Law for such things as statutory sick pay, statutory paternity pay, holiday pay, the right not to be dismissed unfairly or without notice, the right to join the company pension scheme etc (these are not available to the self employed) Determining employment status Recent court cases indicate there is no single satisfactory test governing the question of whether a person is employed or self-employed. HMRC advice is to consider all the factors that are present in, or absent from, a particular case then weigh those pointing to employment against those pointing to self-employment. Having done that, a picture will emerge from which employment status can usually be ascertained. The following is a list of the factors to be taken into account in determining whether a worker is employed or self employed: Mutuality of obligation Right of control Reed Elsevier UK Ltd FA 2015

3 Provision of own equipment Right of substitution and engagement of helpers Financial risk Opportunity to profit Degree of integration into the organisation Right to terminate the contract The number of paymasters This is by no means an exhaustive but it does include the most important criteria. We shall examine each in turn Mutuality of obligation Where an engager is under an obligation to provide work and the worker is under a similar obligation to accept the work and to perform the tasks delegated to him, this usually points to the relationship being one of employment. If a worker is self-employed, he will have no guarantee of work and even if work is offered to him he is under no legal obligation to accept the work offered. Employees on the other hand are rarely allowed the freedom to refuse work allocated to them. The existence of any mutual obligation between the parties will usually be obvious from any service contract between the two parties. Employees usually have an employment contract which sets out the terms and conditions under which they are to perform duties for their employer Right of control In a typical employer/employee relationship, the employee will exercise very little control over what he or she does on a day-to-day basis. There is typically a master/servant relationship between an employer and an employee. An employer will typically tell an employee what to do, how to do it and when to do it by. The fact that a worker may be told how to perform duties will usually be seen as a strong pointer to employment. On the other hand, a self-employed person will have far more control over the jobs that he or she undertakes and the deadline for completion of those jobs. However where the worker is an expert (for example a ship's captain or a brain surgeon), the issue of control would probably not be seen as material. For example, take a brain surgeon who works for the NHS. Whilst performing the surgery, he is in total control over what he does, how he does it and how long he takes to complete the task. However, this does not mean that he is self employed. This is an unusual situation and the issue of control in this instance will therefore carry less weight. Reed Elsevier UK Ltd FA 2015

4 28.6 Provision of own equipment When considering whether a worker is employed or self-employed, HMRC will look at who provides the tools for the job in hand. An employee is rarely responsible for providing his or her own equipment. When we turn up for work we expect our employers to provide us with a computer, a printer, a telephone and some stationery etc. A self-employed person, on the other hand, will customarily be responsible for providing the necessary equipment to enable him to undertake the work offered Right of substitution and engagement of helpers The ability to provide a substitute and/or engage helpers is something HMRC look at closely when deciding whether a worker is employed or self-employed. An employee will have no freedom to send a substitute in his or her place if, for whatever reason, they are unable to perform their duties. Similarly an employee will rarely be allowed to engage the services of a helper or assistant. On the other hand, if a self-employed person has contracted to do a job and is either sick or double-booked, that self-employed person will usually have the freedom to provide a substitute to complete the job in his place. This was a crucial factor in the case of Hall v Lorimer. In this case the Court, after much deliberation, concluded that a vision mixer was a self-employed person largely because on a handful of occasions, he had been able to provide a substitute to fulfil particular contracts. When looking at the right of substitution, HMRC will require evidence of occasions when a substitute has actually been used to fulfil a task. Therefore the presence in a contract of a clause which gives the worker the right to provide a substitute is not usually enough. The worker must clearly show that a substitute has in fact been engaged Financial risk Individuals who risk their own money by (say) buying assets needed for the job, bearing the running costs and paying for overheads and materials, are almost certainly self-employed. Employees are not usually expected to risk their own capital. An example of a financial risk is where a worker incurs significant amounts of expenditure on training in order to obtain the skills needed, which are then used in subsequent engagements. This can be treated as a pointer to self-employment if there is a real risk that the investment in training would not be recovered from income from future engagements. Self-employed workers may also be required to rectify unsatisfactory work in their own time and at their own expense. Financial risk could also take the form of quoting a fixed price for a job, with the consequent risk of bearing the additional costs if the job overruns. The risk of making a loss is a very strong indicator of self-employment and can be a decisive factor on its own. Reed Elsevier UK Ltd FA 2015

5 28.9 Opportunity to profit A person whose profit (or loss) depends on the capacity to reduce overheads and organise his work effectively is likely to be self-employed. People who are paid by the job will often be in this position. For example, a person who quotes a fixed price may well be able to complete the task ahead of schedule or at a lower cost than originally envisaged Degree of integration into the organisation Establishing whether a person becomes 'part and parcel' of the engager s organisation can be a useful indicator. An employee will be integrated into the business of his employer. For example, an employee will usually have his or her own desk, a designated computer with which to work, an address, a land line phone number, his or her own stationery, access to normal employee facilities such as the staff restaurant, and access to the employer premises (often by means of a security pass). Employees will also be allowed to join company pension schemes, receive invitations to staff functions such as Christmas parties and perhaps have a car parking space. Contrast this with the position of a self-employed person, who will not be as integrated into an engager s business, will not have a desk or a computer or access to the business premises without prior appointment and will not have the employee type benefits such as those described above Right to terminate contract A right to terminate an engagement by giving notice of a specified length may be viewed as indicative of a contract of employment. On the other hand a contract for the services of a self employed worker will usually end on the completion of the particular task The number of paymasters A typical employee has one paymaster he is paid by his employer and no-one else. However, if a worker typically performs services for a number of different businesses, he is more likely to be self-employed Some leading tax cases As the criteria to determine employed v self-employed have been largely built up over the years in the Courts, it is important that you are familiar with the leading tax cases in this area. Here we shall look at four tax cases. Fall v Hitchen (1973) Mr Hitchen worked for a theatre company under a standard contract approved by Equity (the British Actors Union). Under the contract Mr Hitchen would attend rehearsals and performances over a period of five to six months and either party could terminate the agreement by two weeks written notice. Reed Elsevier UK Ltd FA 2015

6 Mr Hitchen worked specified hours and received a fixed salary paid at regular intervals. He was provided with stage costumes and was permitted by the theatre company to seek work elsewhere in times when he was not needed. Mr Hitchen argued that he was self-employed. However the Courts rejected this claim and held that his contract was a contract of service. As such, he was treated as an employee and any income was assessed as employment income. Following Fall v Hitchen, HMRC assessed all actors engaged under standard Equity contracts as employees. However, since 1993, it has been agreed that actors in general should be treated as self-employed individuals rather than employees engaged in a succession of employments. However on occasions where an actor is engaged in regular work, for a fixed salary for a particular employer, HMRC will regard that contract as a contract of service and charge any income under the employment income rules. This will be the case for actors who regularly appear on our screens in soap operas etc, as they perform services for a regular salary for one production company in a specified role. Market Investigations Ltd v Minister of Social Security (1969) A market researcher worked as a part-time interviewer for a market research company. Her job was to ask pre-set questions devised by the market research company to members of the public. The market researcher had little or no control over what she did on a day to day basis she was told what to do and how to do it. In addition, any equipment necessary for the job was provided by the market research company. The Department of Social Security successfully argued that the worker should be treated as an employee for NIC purposes. As such, any earnings paid were subject to Class 1 National Insurance Contributions. Subsequent tax cases on the subject of employed versus self-employed have made reference to the Judge's summary in the Market Investigations case. In his summing up, the Judge made reference to the use of the various criteria we have already looked at, such as the provision of equipment, the ability to hire a helper, and the degree of control and financial risk etc. In this particular case, the Judge found that the market researcher was not in business on her own account and could not therefore be regarded as a selfemployed individual. Hall v Lorimer (1993) Mr Lorimer was a vision mixer who worked for a number of different television companies. His work involved him undertaking a series of short-term contracts typically of one to two days each. Mr Lorimer worked for a number of different production companies, and over a three or four year period in the 1980s he received income from about 20 different companies. Mr Lorimer's work was always undertaken on company premises using equipment provided by the studio company. This was largely due to the specialist nature of the work. Mr Lorimer issued the production company with an invoice after each job and was registered for VAT purposes. Mr Lorimer was responsible for making good his own losses and ran the risk of incurring bad debts. To guard against losses he had an insurance policy which covered him in the event of sickness. Reed Elsevier UK Ltd FA 2015

7 During the period in question, Mr Lorimer was unable to fulfil his obligations on a handful of contracts and in his place he provided a substitute worker. HMRC argued that Mr Lorimer had a series of employments and hence should be taxed on employment income. They put particular emphasis on the fact that Mr Lorimer worked on studio premises using studio equipment. However, the Courts agreed that Mr Lorimer was self-employed. The Courts commented that it was important to look at all the relevant criteria and to make a judgement based on an evaluation of all the factors rather than one or two in particular. However, the Courts were particularly swayed by the fact that Mr Lorimer could, and indeed did, hire a helper to assist him in the performance of his duties and this ability to provide a substitute is not an option typically available to an employee. Autoclenz Ltd v Belcher (2011) Autoclenz Ltd provided car cleaning services to motor retailers and vehicle auctioneers. The work was carried out by teams of car valeters who were engaged explicitly on a self employed basis. Twenty of the valeters claimed that they were not self employed and therefore were entitled to the national minimum wage and holiday pay. The Supreme Court found that the valeters were employees. The Supreme Court reached its decision by analysing the contract between Autoclenz and the individuals. Amongst other clauses the contract gave the workers: The right to provide a substitute; No mutuality of obligation; and A requirement to provide their own insurance, cleaning materials and equipment at their own cost. If the terms of the contract had represented the true nature of the contract, then the individuals would be considered to be self employed. However, the Supreme Court found that in actual fact the individuals had to do the work personally and could not provide substitutes. In addition, Autoclenz undertook to offer work and the individuals were obliged to carry it out, indicating the existence of mutuality of obligation. As the other real terms of the contract were not inconsistent with employment and the valeters were not in business on their own account, the Court found that they were employees. Under normal contract law, the terms of a written contract cannot be ignored unless the contract does not reflect the true position for example where a clause has been inserted to give the impression that the position is different from reality (i.e. where the contract is a sham). Following the Autoclenz case, the Courts can ignore the written terms of a contract and instead look at the true contract. This true contract represents what the parties have actually agreed which may be markedly different from what is written down on paper. The true nature of the contract is determined by looking at all the evidence, and in particular the behaviour of the parties in practice. Reed Elsevier UK Ltd FA 2015

8 In the Autoclenz case, the written contract dressed up the relationship between the engager and the worker as one of self-employment when, on an investigation of the facts, the reality was that the workers were employees. Reed Elsevier UK Ltd FA 2015