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Guidance to help you understand the different types of employment status and prepare for the hidden risks faced as engagers of sole traders

DIFFERENT TYPES OF EMPLOYMENT STATUS

Employment status is used as a process of categorisation for two distinctly different purposes; to indicate what rights that individual is eligible to, and how much tax that individual is subject to.

It’s important to note that the categorisation framework for the purpose of rights and tax is not aligned. In other words, the categories used to determine employment rights and the categories used to determine tax liability are not equal.

CATEGORIES OF EMPLOYMENT STATUS

In general, when we talk about employment status, there are three main categories an individual might be classified as. An individual can be classed as multiple employment status categories depending on their work e.g. having a day job as an employee and a self-employed evening job, or a limited company contractor operating inside IR35 (employee) on one contract, but outside IR35 (self-employed) on another.

Employee

An individual providing services under a contract of employment, also known as a contract of service.

More specifically, an employee is an individual that is contractually obligated to provide services personally. In other words, as part of their contract, an employee is consistently offered and obligated to accept work whilst under the supervision and control of their employer.

An example of an employee might be a teacher working a regular 9-5 under a contract of service.

Worker

Viewed as somewhat of a middle-ground between employment and self-employment.

In reality, a worker is an individual that provides services on a casual basis (i.e. with no obligation to be offered nor to accept work) usually to a single business, and must provide those services personally. These services are not provided as a representative of a limited company but as an individual.

An example of a worker would be anyone working on a zero-hours contract or a “gig economy” worker such as an Uber driver.

Self-employed and contractor

An individual who runs their own business (as a sole trader or limited company) and must take full accountability for the successes or failures of that business might be considered self-employed or a contractor.

Those who are self-employed are responsible for how and when the services of their business are provided, invoice for their payment rather than being paid through PAYE, have autonomy over the services provided, and can hire someone else to do the work on their behalf.

An example of someone who is self-employed might be an individual providing freelance graphic design services to multiple clients.

ADDITIONAL EMPLOYMENT STATUS CATEGORIES

In addition to the previously outlined three main types of employment status, there are two further categorisations which alter how a worker may be treated for tax and employment rights. These relate to the roles and responsibilities of the individual and so the individual may be both one of the below categories and one of the above.

Director

A director is an individual that is legally responsible for the running of a company. Duties that usually befall a director are ensuring the correct filing of accounts and tax returns, the keeping of company records and reporting of changes, and the payment of corporation tax, among other responsibilities.

In this context, we are not talking about a limited company contractor who is also a director of their own limited company.

Office holder

An office holder is an individual appointed to a substantive position by a company or organisation. They tend to have minimal duties within the company and do not receive any form of payment for the duties performed other than a potential voluntary payment (honorarium) subject to tax and national insurance. They can however also be an employee of the company for which they receive payment.

An individual acting as an office holder works independently and is under no contract in relation to the duties they undertake as an office holder. An example of an office holder might be a trustee, trade union secretary, or company director.

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DIFFERENTIATING BETWEEN EMPLOYMENT STATUS FOR TAX AND FOR RIGHTS

When it comes to employment status, there is a disparity between the categories used to determine an individual’s tax liabilities, and the categories used to determine an individual’s employment rights. This can result in the same individual being taxed under one category but given the rights of another.

A common example is a limited company contractor operating “inside” the IR35 legislation which is a measure strictly in relation to tax liability. Such individuals pay tax like an employee but are not automatically awarded the same employment rights.

Because status for tax and status for rights are dealt with by separate government departments, they have different methods of determination for each.

Employment status for rights

Employment status serves as an indicator for the employment rights that an individual is entitled to as part of their job.

For example, employment status impacts upon whether or not an individual is eligible for holiday pay, maternity leave, or workplace benefits etc.

When we consider employment status for rights, there are three categories of employment status that an individual might fit into:

Employed
Self-employed
Worker

What rights are each category eligible to?

Employed: An employee is afforded the most rights including but not limited to statutory minimum level of paid holiday, statutory parental leave, statutory sick pay, statutory redundancy pay, and protection against unfair dismissal.

Self-employed: Being self-employed means that an individual is their own employer. As such, a self-employed person is not eligible for statutory sick pay, parental leave, or other rights associated with employment. Self-employed individuals are however entitled to certain protections such as against discrimination and for their health & safety.

Worker: A worker has limited rights when compared to an employee. Workers are eligible to a statutory minimum level of paid holiday and National Minimum Wage but are not usually entitled to minimum notice periods, flexible working, or statutory redundancy pay.

Employment status for tax purposes

The categorisation of individuals under employment status for tax serves as an indication to HMRC as to how much tax and National Insurance contributions should be deducted from each person based upon the position they fulfil, or the services provided.

For employment status for tax purposes, there are only two categories an individual may be classified as:

Employed
Self-employed

What difference does it make?

Employed: An individual classed as employed for tax purposes pays full tax and National Insurance contributions (NIC) on all relevant income, much like an employee.

The engager of sole traders classed as employed for tax purposes will need to pay Employer’s NIC resulting in a tax liability if this determination is not made or made correctly.

Engagers of limited company contractors classed as employed for tax purposes will need to deduct the relevant tax and NIC from the individual’s fee and pay this to HMRC on their behalf (or utilise an alternative structure such as an umbrella company). This comes under the IR35 legislation – a targeted legislation for handling the employment status for tax of limited company contractors.

Self-employed: An individual classed as self-employed for tax purposes is exempt from PAYE and so is responsible for paying their own taxes.

A sole trader will pay full tax and NIC on all relevant income via Self-Assessment.

A limited company contractor classed as self-employed for tax purposes can pay themselves more tax efficiently through a mix of salary and dividends.

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MISALIGNED EMPLOYMENT STATUS FRAMEWORK

The disparities presented above between the frameworks for determining an individual’s employment status for both rights and tax purposes only goes to show that the need for alignment between the two has never been more necessary.

It begs the question of whether the two frameworks will ever be aligned unless a third category of ‘worker’ is introduced into the determination process for employment status for tax in order to mirror the categories set for employment rights.

There are so many different ways for an individual to provide a service. Whilst having the benefit of seeming simple, when it comes to HMRC’s categorisation of employment for tax purposes, narrowing it down into two distinct categories could be construed as an oversimplification.

Another consideration which has been an increasingly common concern for the industry is whether an individual might be classed as employed for tax purposes yet self-employed when it comes to their rights. An individual put under the same determination tests might receive a different categorisation for their rights than for their tax classification. This is a clear argument for why the frameworks desperately require aligning.

GET THE SUPPORT YOU NEED

Here at Qdos, we have been supporting 90,000+ contractors for well over two decades. When it comes to IR35, you can trust us and our process. We have, after all, spent over two decades fine-tuning our skills.

The most important thing we can provide to you is our expert team. Through them, we can ensure that you are not alone during any part of the process of implementing your new policies. We also offer a range of bespoke training packages to suit the requirements of your business. Ensuring confidence in the knowledge of your employees.

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