Employment status and the cost of non-compliance explained
The emergence of the gig economy in recent years has brought into sharp focus the issue of employment status of the individuals engaged by the likes of Uber, Deliveroo, Addison Lee and other companies that benefit from the on-demand workforce.
Many of these businesses engage thousands of courier drivers, taxi drivers and riders as self-employed people – it helps them operate a lean, cost efficient and flexible workforce. But while for millions of self-employed people across the UK working in this manner suits, there have been numerous cases of gig economy workers successfully claiming employment rights.
This is because judges have ruled that the terms of their contract do not reflect self-employment. Instead, Uber drivers and more recently, Addison Lee couriers, have been deemed to be ‘workers’ and are therefore entitled to employment rights, such as holiday and sick pay and minimum wage.
While this change in status (from ‘self-employed’ to ‘worker’) doesn’t have any bearing on tax (with individuals retaining self-employed tax status), it has nonetheless shone a light on the importance of making well informed employment status decisions from the outset.
But why is it so important that businesses engage individuals under the correct employment status with regards to tax? And what are the implications of getting things wrong?
In this article, we introduce the issue of employment status, its relationship with tax status and answer a number of frequently asked questions.
What is employment status?
When a person is engaged by a business to carry out work, they tend to fall into one of three employment statuses and this determines what tax they are required to pay, as well as the employment rights they are entitled to:
Self-employed (sole traders/limited company contractors)
As the term suggests, the self-employed work themselves and are responsible for their own tax. They do not receive employment rights.
This is a halfway house, in between self-employment and employment. Workers receive some employment rights but stay self-employed for tax purposes. This status mostly applies to gig economy workers.
Employees get employment rights, with employers (including umbrella companies) tasked with deducting the appropriate tax and paying this to HMRC.
Is employment status the same as IR35?
No, but it is related.
IR35 was an additional piece of legislation brought in to sit on top of the status rules already in place. Prior to the introduction of IR35 in 2000, workers and engagers could avoid status issues through the use of a limited company, or PSC.
IR35 relates solely to employment status for tax purposes, though, and will only impact individuals who provide their services through a limited company. IR35 itself doesn’t apply to sole traders (like gig economy workers) and has no correlation with employment rights – only tax. For example, if a contractor works outside IR35, they are self-employed for tax purposes only. Inside IR35 and they are classed as employees for tax purposes but have no automatic claim on employment rights.
The wider issue of employment status on the other hand, can have a bearing on employment rights. There remains a disconnect between employment rights and tax, however. Tax will come into the equation if, for example, HMRC viewed a self-employed worker to be an employee. In this instance, the engager would be liable for missing employment taxes for the duration of the contract to date.
Why is it important that businesses engage workers under the correct employment status?
Other than ensuring that self-employed workers who need employment rights receive them (and therefore mitigating court cases), if a business engages an individual under the incorrect employment status they will be liable for unpaid Employers NICs.
For businesses engaging just one self-employed worker, the liability (which can also include interest and HMRC penalties) can mount up considerably. For firms with vast numbers of self-employed workers on assignment, like construction firms, the potential liability could be staggering.
Do businesses have legal obligations in this area?
Businesses are not required by law to determine employment status – not in the way that most firms are following IR35 reform in the private sector.
That said, the threat is effectively the same to businesses, who HMRC will approach should it take the view they have been enabling false self-employment – a scenario which means firms avoid tax. With this in mind, companies looking to protect their own financial interests have an obligation to ensure compliance in this area.
What is HMRC’s view of employment status? And will they treat it like IR35?
After HMRC rolled out IR35 reform in the public and private sectors, it seems likely their focus will turn to employment status in general. With millions more sole traders than contractors in the UK, the tax office has a wider pool in which to cast its net. Looked at through HMRC’s eyes, it’s a big opportunity.
How can businesses assess employment status?
The questions asked to decide if a sole trader should be self-employed or employed (and therefore paying the right tax) are the same as those used when assessing IR35 status. As a result, businesses can assess employment status in a number of ways, including engaging the help of a specialist such as Qdos.
Does ‘Construction Industry Scheme’ (CIS) compliance have anything to do with employment status?
No. The CIS is an initiative where a construction business will deduct money from a self-employed worker’s (subcontractor’s) payments before passing it on to HMRC. These deductions count towards the subcontractor’s tax and National Insurance contributions.
There is a dangerous misconception among construction businesses that CIS compliance means all tax obligations are in order. However, CIS only covers the worker’s tax payments, not employer’s National Insurance (NI) and doesn’t include any assessment of the worker’s status.
If HMRC found that a construction firm had engaged subcontractors under false self-employment, the business would be liable for employer’s NI, potentially along with any interest or penalties HMRC deems fit.
What else should businesses know?
Like IR35, employment status can be confusing and there are lots of factors to consider when deciding if an individual should be engaged as a self-employed person, a worker or even employed. However, with the right support, businesses can ensure their tax compliance and protect themselves against the risks involved.
Here are two key takeaways:
- The tax risk occurs when a self-employed person’s contract and/or working practices reflect employment, not ‘worker’ status – this is a relatively new status and has no implications on tax currently.
- Despite it not being a legal obligation, it’s important that all businesses working with self-employed people carry out fair and well-informed employment status decisions to ensure these workers are operating under the correct tax status. The financial consequences of non-compliance can be severe.
For more information about how this issue could affect you, take a look at the dedicated employment status webpage.
In addition to our award-winning IR35 services, we provide a range of solutions to help ensure businesses are engaging self-employed workers under the correct employment status – from employment status assessments to insurance. For more information, please get in touch on firstname.lastname@example.org or 0116 478 3390.