Chartered Accountant | Swindon | ACCA qualified | Company Accounts

STATUS DISPUTES: EMPLOYED V SELF EMPLOYED

The terms of the engagement will determine whether an individual is employed or self employed.

• Contract of service : employed
• Contract for services : self employed

The issue of status disputes has taken on new significance recently with the clamp down on the construction industry. Several leaflets have been produced by the Inland Revenue in an attempt to assist contractors in deciding whether staff are employed or self employed. In any event, it is now clear that the assumption that PAYE does not apply to the construction industry, as it is replaced by the construction industry tax deduction scheme is incorrect : all workers must first be categorised as either employed or self employed, and then after this, the deduction scheme will be applied as appropriate to those workers who have been classified as self employed.

Consequences of reclassification

Before considering the specific tests, it is worth considering the consequences of having employees reclassified. The main impact is on retrospective National Insurance Contributions, as the difference in tax liability is often marginal. In many cases, the Inland Revenue will set off the Schedule D tax paid against the Schedule E liability, and therefore the main liability arises through the additional NIC due. The liability is calculated as follows:

• Class 1 primary and secondary contributions on amounts paid
• Less Class 2 contributions paid - at the DSS discretion

This entire liability is due from the employer, and Class 4 contributions being refundable to the employee.

Example 1

A computer consultant was engaged for a period of 9 months during 1996/97 during which time he was paid £25,000 gross. It has now been decided that he was employed during that period. The additional NIC liability is:

Additional NIC Liability

This might be reduced by the class 2 contributions paid for the relevant period.

Inland Revenue criteria

Whether a person is employed or self-employed depends on the facts of the case. The Inland Revenue list the following factors as pertinent; none alone will determine the case, but will add to the overall picture to be considered.

Comparison of Employed v Self-Employed

• you provide the materials and plant for the job
• you bid for the job and will carry the extra cost if your price is too low
• you have a right to hire others who answer to you and are paid by you
• you are paid an agreed amount no matter how long the job takes
• you can decide how and when the job is done within an overall deadline
• you work for a large number of different people during the course of a year

Pointers that you are an employee include:

• you do not risk your own money and there is no possibility that you could lose money on the job
• you are paid by the hour, day, week or month
• you have no business organisation, for example a yard, materials or workers
• you supply only your own small tools
• the person you are working for has the right to tell you what to do, and where and when, even if this rarely happens in practice

Example 2

A construction industry employer with 9 operatives working regularly, paid £400 per week each is visited in October 1997 regarding classification of his workers. It is decided that they should have been classified as employees with effect from 6 April 1997, and by the time the investigation is concluded it is late December. The employer finally agrees to put them "on the books" from 1 January 1998, and has the following retrospective NIC liability:

Additional NIC Liability

The sum of £4,105 could be recovered from the employees using the rules for under deduction of contributions, leaving the employer to bear the cost of £22,270. This example ignores Class 2 contributions.

Tests considered by the Contributions Agency

The classification of an individual as an employed earner crystallises the liability to Class 1 contributions. As with PAYE, it is insufficient to agree with an "employee" that they are no longer an employee, and are self employed.

Both parties potentially gain by the employee being classified as a self employed earner, and this is well understood by the DSS, who have developed the following tests to demonstrate the classification of an individual.

Although the CA use different tests to the Revenue, there is an agreement between the two that decisions on status by one will bind the other, provided the full facts were known.

A. Mutual Obligations
Is Employer obliged to offer work to John, and if so is John obliged to do the work so offered? If not, there cannot be an employee relationship, however mutual obligation can be created by financial interdependence or by custom and habit. If this mutual obligation is satisfied there may be an employment: further tests are needed.

B. Control
Is Employer's control over John such that Employer may dictate not only that John himself does the work and that it shall be done where and when Employer says, but also that it shall be done in the manner that Employer specifies. This test carries a great deal of weight with the DSS as it was instrumental in the case of Short v J & W Henderson Ltd in which it was held that the four indicators of a contract of service (employment) were:

• the employer's power of selection of his employee
• the payment of wages or other remuneration
• the employer's right to control the method of doing the work
• the employer's right of suspension or dismissal

If this degree of control exists, there is a contract of service (employment); if not, there may be, but further tests will apply.

C. Integration
Is John part and parcel of Employer's business? Is John doing what Employer is in business to do? If so, there is an employment, if not, a further test will apply.

D. Economic reality
Is John really in business on his own account? Does he have capital invested in it? Does he own his own equipment? Does he hire his own helpers? Does he stand to make profits or losses depending on how well or badly he manages his work? If yes, John is self employed, if not he is an employee.

If the results of all the tests are inconclusive, the DSS will look to any written agreement which is consistent with the facts to resolve matters. Should employers wish to secure their position by the use of an agreement based on the above, it should be stamped with a 50p stamp by the Stamp Office so as to be admissible as evidence.

Construction industry visits

The Contributions Agency have a target of 10% of all construction industry employers for visits this year, and are mounting pressure to reclassify such staff. Clients need to be educated that the construction industry is not a "special case" as regards this decision, and the 714/715 scheme is not an alternative to PAYE. The advice in the booklet is clear, and practitioners have sufficient expertise to advise their clients accordingly: this needs to be addressed now! The indications are that the issue of this booklet will be used as a "marker" to retrospectively reclassify and obvious cases. The date indicated for such treatment is 5 April 1997! Employees in the construction industry will not be retrospectively reclassified before that date unless there is a clear case of tax evasion by the main contractor.

Consequences for the subcontractor

The subcontractor who is reclassified as an employee is faced with cessation of his self employment as at 5 April 1997 if he has no other work outside of the main contractor. In this eventuality the following are worth noting:

• Where he is not expecting to obtain any other self employed work covered by the Construction industry scheme, he is encouraged to hand in his tax deduction certificate. However, where he believes that he will continue to obtain private work and other jobs covered by the scheme it should be retained