Self-Employed or Employed? Tax Issues for Consultants

Self-employed or employed? With confidence returning to the economy, many businesses are seeking to increase their workforce, but don’t want to increase their fixed costs by employing workers. As a result many workers are being approached by firms to enter into self-employed consultancy agreements. Whilst this may suit the engager and worker; the Taxman’s position is that the majority of individuals are actually employees and should be on the books. However, there are legitimate consultants out there that should be trading as a self-employed worker. So what are HMRC looking at when they try to assess a worker’s tax status?

Self-Employed
There are no laws setting out exactly who is employed or self-employed. Instead various “tests” have been developed through the courts and tribunals that can be applied to an individual’s situation to try to make a decision. Using these tests HMRC will only accept that a consultant is self-employed on a balance of various factors and if they can demonstrate that the way they work is more like a self-employed individual than an employee. These tests and how they are interpreted are set out below:

Factor	Self Employed	Employee
Mutuality of obligation	Would be free to decline work and the engager is under no obligation to offer future work.	The employer is obliged to offer work, and the employee is obliged to do as the employer requests.
Right of substitution	May sub-contract work or being in assistance.	Cannot provide a substitute to carry out the work.
Provision of own equipment	Will normally supply all small tools and bring in or hire plant.	Employer provides the majority of tools but the employee may supply small amounts.
Length of contract	Generally a fixed-term or short-term contract.	Contract will generally be open ended after probation period (if applicable).
Employee benefits	Unlikely to be entitled to any type of benefits.	Entitled to holiday leave, sick pay, maternity leave etc.
Financial risk	Is able to profit by working more efficiently or alternatively incur a loss on unsatisfactory or overdue work.	Paid in accordance with the national minimum wage.
Running as a business	Possibly have own website, own a premises, spend money on advertising etc. May also need to have Public Liability and Professional Indemnity insurance as required	Doesn’t incur any expenses personally and is part and parcel of the engaging business.

Passing more of the above tests does not automatically guarantee you are either one or the other, as some tests may carry more substance depending on your line of work. It is worth noting that the onus is on the engager of the work to determine your correct employment status and, if successfully challenged by HMRC to be an employee, the engager will be liable to pay any additional taxes and penalties.

Limited company

Under pressure from engagers and for tax reasons, many individuals have historically chosen to run their own Limited company . Not surprisingly this includes many workers who should have been treated as employees. To combat this, HMRC introduced legislation aimed at ‘Personal Service Companies’ to catch those abusing the rules. This is known as “IR35” after the press release that announced the rules.A further option for consultants is to operate their business through a limited company. This benefits both the engager and consultant as the engager does not have to pay employers’ national insurance contributions of 13.8% and avoids the tax risk of self-employment, whereas the self-employed consultant benefits from more generous rules for claiming expenses and lower overall tax rates.

Where it applies, the effect of IR35 is that the personal service company must pay “deemed PAYE” on any money taken out of the company as dividends as though it were a salary. Although IR35 has caused a lot of anxiety for self-employed consultants and has proved costly for certain individuals, the rules are not enforced very well by the Taxman. Consultation on changes to the rules to make them more effective are ongoing and we will have to wait and see whether HMRC becomes more aggressive with IR35 in the future.

If you are being approached with a consultancy agreement and have any queries which entity you should be trading as, please contact us to discuss how you can minimise the risks.