Contractor or employee? Speed read guide
If you have engaged or are thinking about engaging a contractor for your business, it is essential that you consider the following two things:
Will the law deem them to be an employee?
Might HMRC deem them to fall inside the IR35 regime?
Employee or self-employed?
A company may have engaged a contractor and agreed with them that they are self-employed rather than an employee of the company. Agreeing that the contractor will be self-employed brings with it certain advantages for both parties. For example, from the contractor’s point of view, the arrangement is more flexible. From the company’s point of view, it won’t have to pay sick pay, holiday pay or employer’s national insurance contributions. However, it is not quite as straightforward as both parties agreeing that the contractor is self-employed. The law in this area is quite complex, and, in certain situations, the contractor will be deemed by the law as an employee, regardless of the parties’ intentions.
Why does it matter?
The distinction in employment law between the employees and self-employed independent contractors is significant for several reasons, including:
Rights - only employees are entitled to sick pay, holiday pay, redundancy pay, maternity/paternity rights, minimum notice periods if their employment will be ending, and the right not to be unfairly dismissed. Self-employed contractors are not afforded these protections.
Tax – we will cover this further below in the section regarding IR35, but employees and self-employed independent contractors are subject to different tax treatment.
TUPE - only employees are entitled to be automatically transferred to a purchaser of their employer’s business.
Liability - employers are vicariously liable for their employee’s acts, which are carried out in the course of their employment. This does not generally apply to the actions of self-employed contractors
Insurance - employers must take out employer’s liability insurance to cover the risk of employees injuring themselves at work. Self-employed independent contractors are responsible for their own insurance.
How to tell the difference?
There is an abundance of case law and information on this question. However, the following are some key indicators that someone is an employee:
They are required to work a set number of hours per day/week and must work the hours stipulated in their contract.
They are paid a regular salary (e.g. £x per annum / £x per month)
They cannot send in a substitute to perform their work.
They are entitled to holiday pay, sick pay, maternity/paternity pay, redundancy pay, to participate in the company pension scheme and to receive a minimum period of notice if their employment is being terminated.
They perform their services under the direction of another (i.e. a manager or supervisor is responsible for their workload and the work they carry out).
The company provides the equipment/materials required for their work.
They are an integral part of the company’s operations (as opposed to being able to offer their services to the world in general).
They only work for the company, or if they do have another job, it’s completely different from their work for the business.
They are integrated into the company (for example, they wear a uniform or have a company email address).
Key indicators that someone is a self-employed independent contractor:
The company is not obliged to guarantee the contractor work, and the contractor is not obliged to accept any work the company does offer them.
They can send in a substitute to carry out their work.
Their contract is structured by reference to completion of a project or piece of work, rather than duration (e.g. 6 months / 1 year).
They can control where, when and how they carry out their work (subject to any contractual deadlines)
They are not paid when they do not work.
They often provide their own equipment, working space and materials.
They carry out work for other clients.
They are responsible for their own insurance.
The arrangements can be terminated at any time, subject to any agreed contractual notice periods.
In reality, the distinction often only becomes an issue from an employment law point of view if the contractor raises it as an issue. However, that is not a position you want to find yourself in. For example, if a contractor provided services to your company for a year and you then decided you did not want to use them anymore, they might at that point try to claim that they were, in fact, an employee of the company all along. If several of the employed status indicators are present, they might well be successful in their claim that they were an employee. If so, they could be entitled to back pay in respect of holidays, notice, redundancy or even be entitled to take a claim for unfair dismissal. It is therefore vitally important to:
carefully document the terms of your contractor arrangements; and
ensure that the working relationship more closely mirrors the features listed above as regards indicators of a self-employed contractor and not those of an employed person.
IR35 (off-payroll working) regime
The IR35 regime is a set of rules designed to combat tax avoidance/reduction on disguised employment. Changes to IR35 are coming into effect on 6th April 2021.
The changes to IR35 are being introduced because the government believes that contractors are exploiting a loophole in the tax system, which allows them to work through their own companies for the primary purpose of it being more tax efficient for them. This way of working also benefits the entities who engage the contractor’s company because they do not have to pay employers’ national insurance contributions or give them employee benefits like holiday pay and sick pay. Many contractors operating in this way are not genuinely self-employed contractors; they are simply hiding behind their companies to pay less tax.
If a contractor’s work falls within IR35, they will be treated for tax purposes as an employee of the entity which engaged their company’s service. This means that the contractor will have to pay national insurance and income tax, and the entity which engaged them will have to contribute to the national insurance payments. If a contractor is treated as falling outside of IR35, it means that HMRC sees the contractor as genuinely self-employed, and they will be treated as self-employed for tax purposes and thus free to pay themselves in the most tax-efficient way.
To determine whether a contractor falls inside or outside of IR35, HMRC uses similar (but not identical) criteria to those discussed above. The following is a useful tool for both contractors and the entities engaging them: https://www.gov.uk/guidance/check-employment-status-for-tax
The impending changes to IR35 (from 06 April 2021) mean that medium and large sized business will be responsible for assessing the contractor’s employment status, not the contractor. Small businesses are exempt from this obligation. A company is ‘small’ if it satisfies two or more of the following criteria:
its annual turnover does not exceed £10.2 million;
its balance sheet total is not more than £5.1 million; and
it has no more than 50 employees.
In addition, a company is always small for its first financial year.
This does not mean, however, that small companies are not subject to IR35. It simply means that the responsibility for determining employment status falls to the contractor if they are providing services to a small company.
To mitigate the risk of a contractor being deemed to fall within IR35, you should:
carefully document the terms of your arrangements with contractors (these terms must reflect the reality on the ground and must not simply be an effort to avoid the contractor falling within IR35); and
ensure that the working relationship more closely mirrors the features listed above as regards indicators of a self-employed contractor and not those of an employed person.
If you require any advice or guidance in relation to your arrangements with contractors, please get in touch with us.
Anna Cartwright, Associate
Turley Legal
15 March 2021