The importance of understanding Employment Status: Jennie Brown, Streets Chartered Accountants

 The importance of understanding Employment Status: Jennie Brown, Streets Chartered Accountants

In this column, Jennie Brown, Tax Partner at Streets Chartered Accountants, discusses the significance of Employment Status.

Ensuring that an individual understands the significance of their Employment Status is important for many reasons, not least in understanding how they will be taxed on their earnings and any requirement to make assessments with HMRC.

This can be a complex area however; this article has been prepared to give an overview of some of the key considerations.

First, coping with terminology, a contract of services is that of an employee-employer and a contract for services is a contractor-client.

Additionally, the rules known as IR35 apply when a person is providing their services through their own Limited Company. IR35 is essentially in position to address the issue, if it were not for the Limited Company that sits between the individual and the end organisation, the connection between them could be viewed as one of employee and employer.

A number of factors are considered, those key ones are highlighted below and are equally relevant to considering the status of a contractor who's self-employed but is not operating through a Limited Company: Supervision, direction and control over work; right of substitution; mutuality of obligation; use of equipment/provision of tools; financial risk; length of engagement; opportunity to profit; part and parcel; quality over quantity/matter of fact.

If discovered to be ‘in-side’ of IR35 then that contract ought to be taxed ‘on-payroll’ and subject to Tax and Class 1 National Insurance through PAYE. The most important thing to note is that this does not necessarily mean the individual will then accrue general employment rights and benefits, they're merely being taxed on payroll, and will often be referred to as a deemed employee for tax in most cases the end client will operate a separate payroll from its genuine employees such situations.

In operating your business through a Limited Company and considering IR35, it’s important to understand where the responsibility sits. For all those providing services through a Limited Company to an organization which sits in the Public Sector, it is the Public Sector Body who, since 6 April 2021, has had responsibility to determine the IR35 position of their workforce. Similar measures are set to come in across the private sector, delayed in April 2021, but the responsibility will only be moved to larger organizations. Therefore, a person providing services through a Limited Company to Private Sector organization is currently responsible for assessing its IR35 status and even when the changes come into the non-public Sector, they may continue to be responsible. They will therefore need to take greater interest whether their end clients may begin to take on this responsibility later on.

In many cases where individuals have contracts that fall within IR35, they may be looking to assess the benefit of continuing to work through a Limited Company.

Where an individual has responsibility to assess if their contract falls within IR35 also it does, there is a specific way they have to ensure this income is taxed and many significantly it means there is minimal expenditure that can be offset, as would be the case if they were employed.

Moving on to someone who does not operate through a Limited Company, and believe they're operating as a sole trader and thus self-employed, in all cases it is the end client’s responsibility to assess the individual’s position, these types of recent case law, there are three main types of employment status:

  • Employee
  • Worker
  • Self-Employed

There are still only two status from a tax point of view; employee or self-employed but if you are a worker you are deemed to become taxed like a self-employed individual but you will accrue some employment rights. This was highlighted in the 2021 case from the business Pimlico Plumbers.

Therefore, we currently have a mismatch between law and tax which with time may be aligned.

In light famous this, the detail within both an agreement and the working practices of how someone undertakes their work are therefore key to fully assess the status of an individual’s employment status.

Looking at the list of key factors, what the rules exist to determine is; do we have somebody akin to that of an employee, have they got set working hours, they are supervised and appraised, provided with equipment and the contracts sets a clear requirement to provide work and undertake the work without substitution, for a considerable length of time. Alternatively, do we have someone taking financial risk, employed by many other businesses, managing their time and working hours and when and where these are undertaken, with the provision that belongs to them equipment.

From a Tax perspective, those people who are fully fledged employees or taxed as deemed employees have limited expenditure they are able to offset against that income and therefore are subject to Income Tax and Class 1 National Insurance on it.

Those who are operating through a Limited Company can offset any expenditure that has been wholly and exclusively incurred in delivering the services and those sole traders and partnerships can offset the business element of any expenditure incurred in delivering anything, thus reducing their taxable profits. Those operating via a Company are subject to corporation tax around the profits in the Company and then need to consider the Income Tax on extracting this, and those sole traders are subject to Income Tax and Class 2 and 4 National Insurance on the profits made in the year.

Therefore, determined by the level of profit an individual anticipates making, they'd also want to weigh up the pros and cons of operating as a sole trader versus a Limited Company.

This is a complex section of legislation, HMRC guidelines and case law and the approach the Government has taken with the varying Covid-19 support measures only reinforces this. Additionally, with lots of employees now working from home they'll no doubt wish to better comprehend the expenditure they can claim to cover the expense of home working there will inevitably be a surge of revisions to contracts to mirror new working arrangements.

It is therefore important to understand the status of how a contract will be performed, before it is entered into and to seek advice. If HMRC would ever challenge a decision in the future it would always be beneficial to evidence a duty of care has been undertaken in attempting to ensure your contract is taxed correctly.

Related post