Alan Pink considers the current Government consultation on employment status.
This is probably one of the most important ‘grey areas’ in the whole of our tax system – replete though that is with such difficult areas of judgement. A pays B for the provision of a service. Is B an employee of A, or not?
Why does it matter?
The question is a very simple one to ask, but it can be an extremely difficult one to answer. But why is the question important?
Employment law is a luxuriant growth in this country, and a lot of employers, particularly those running smaller businesses who are more at the ‘sharp end’, consider that the law is massively unfairly weighted in favour of the employee. In no other area are contracts, freely entered into between parties, so often swept aside and replaced by rules designed to make one of the parties’ lives easier at the expense of the other.
So, the question of whether you are an employee and, therefore, protected by the lush foliage of the employment rights legislation against what would otherwise be the natural consequences of your actions and/or of commercial reality, is very important; because the alternative is basically that you have no such additional rights other than those that ordinary contract law gives you.
More importantly though, from the point of view of the subject matter of this publication, the payment made by A to B has a very different treatment for tax, and particularly National Insurance contributions (NIC) purposes, depending on what side of the line the relationship between A and B falls.
The different tax treatment
If you receive income as a self-employed individual, for a start the mechanism under which you pay tax is different. Rather than having your tax deducted under PAYE before you receive it, the payment will be gross, and it will be up to you to send accounts in to HMRC with your annual self-assessment tax return. Payment of tax is by direct transfer of funds, by way of cheque or bank transfer, in two annual instalments on 31 January and 31 July each year.
As a self-employed individual, you have a different regime determining which expenses you can deduct, and which are disallowable; and (arguably with the exception of the rules relating to travel and subsistence) it is generally easier to get an expense deducted under the self-employed code than under the employed code. If you are self-employed, expenses are allowable if they are incurred ‘wholly and exclusively’ for the purposes of your self-employed business. The general rule for employees is that they must also be necessarily incurred in the performance of the duties of your employment. These words, as a judge once commented, ‘are indeed stringent and exacting’.
Oh, and if you are self-employed, you may also have the joys of VAT to contend with if your turnover is more than £85,000 a year, or if you decide to register voluntarily. An employee’s earnings, by contrast, are outside the scope of VAT.
The National Insurance contributions impact
It’s when one considers NIC that the difference becomes most marked, and indeed it starts affecting the payer as well as the payee in a more fundamental way. Payments made to an employee are subject to Class 1 NIC, which involve employer contributions at 13.8% (over a threshold) and employee contributions of 12% (and possibly 2% depending on the level of earnings).
By contrast, the self-employed are liable to Class 2 NIC of £2.95 per week, and Class 4 NIC of 9% between £8,424 and £46,350; with the rate of NIC dropping to 2% above £46,350.
So, there is a huge difference in the liability, and the main impact of payments being made to a self-employed person is that there is no equivalent of the 13.8% employer contribution.
How can you tell?
The way English law has approached this very important question (important from both the tax/NIC point of view and the point of view of employee rights) has typically been to treat the difference as self-evident but provide case law precedent when it turns out that it isn’t. There is an immense amount of case law, therefore, on this subject, and it is growing all the time.
If one were to take the fairly considerable risk of trying to distil all of these cases down to an essential principle, one would probably define that principle as being the difference between a situation where the payer has control over the payee on the one hand; and where he has no control on the other. However, there are a large number of factors which go into the mix in deciding, in practice, on what side of the line a relationship falls, including:
- whether there is ‘mutuality of obligations’ – that is, whether the payer has to provide work and the payee has to do it;
- whether the individual has to provide his services personally, or can send a substitute;
- whether the individual takes financial risk;
- whether the individual is ‘part and parcel’ of the payer’s organisation;
- whether the individual provides his own equipment, etc., or uses that of the payer;
- whether the worker or the payer decides when the work shall be done;
- and so on.
The Taylor review
The Taylor review was undertaken by a team lead by Matthew Taylor, Chief Executive of the Royal Society of Arts, and was published in July of 2017. The point should be made straight away that there was an awful lot more to the review than a consideration of the distinction between employment and self-employment; however, this point was certainly touched on, with the report basically recommending that there should be greater clarity in the question. Hear, hear, one might say!
Because of its wide-ranging nature, the Taylor review was looking at this question not just from the tax point of view, or even not principally from the tax point of view; but also, from the point of view of who qualifies for employee rights and who doesn’t.
The Government’s ‘response’
In due course, in February 2018, the Government published a consultation paper, one of four, on the specific distinction we are considering here.
It puts forward, basically, three ‘options’:
- moving the law in this area away from case law precedent and into legislation. This would include primary legislation (an Act of Parliament), secondary legislation (statutory instruments) and ‘guidance’. Under this option the law basically wouldn’t be changed but would be written down formally. A parallel to this would be the enactment of the definition of ‘plant’ for capital allowances purposes, which, before the Act codifying it, comprised a whole raft of case law – although not as profuse as the law relating to employment and self-employment;
- the second option would be to change, and simplify, the test itself. The consultation paper asks questions about how the consultees think this would best be done. It points out, no doubt presciently, that a simpler test might not be a better one if it led to easier manipulation of the test, and/or a ‘cliff edge’ situation where failing a simple test pushed the situation over into the ‘wrong’ area; or
- the consultation paper also puts forward, very half-heartedly, the idea of changing the tax and NIC system, so there isn’t such a huge difference on which test is the crucial criterion. This action, which would seem like the obvious one to most people advising on tax and NIC, is basically virtually ruled out at the outset.
What should be done?
The personal view of the author, on the questions raised by the consultation document, is that firstly it is a missed opportunity to make the tax system half sensible, because the Government seems to have told the authors of the document that this one isn’t on the table. Secondly, I would question the benefit, despite the review’s findings, of changing the current status quo with regard to determining individuals’ status. A mess of case law decisions is indeed very unsatisfactory. But would a large quantity of densely written legislation (there doesn’t seem to be any other sort these days), which has to be read in conjunction with multiple regulations and guidance, be any more user-friendly in practice? Simplifying the test could have attractions, but only from the cynical point of view that it would, indeed, make the system much easier for clever planners to manipulate. If you’re a cynic and would like to see this result, you should therefore obviously plump for the simplification option!
