This report from the Office of Tax Simplification was to stimulate debate on the issues around ‘employment status’.
The mammoth 188-page report looked at many of the aspects of the ongoing discussion around employment status. Here, we’ll look at the proposal for a ‘de minimis’ employee status, a ‘withholding tax’ and a ‘third way’ that are concerning some freelancer and contractor bodies.
Current Data on Self-Employment
Government data between September – November 2014 suggested the total ‘in-work’ population in the UK was 30.8 million. Further data from HMRC and BIS shows that between 4 and 5.5 million are currently self-employed (in some form or other – e.g. either self-directing, entrepreneurs, part-time, combining self-employment with employment).
There’s a been a long term shift to self-employment and they believe this generally appears to be a long-running trend, not just a reaction to the recession.
Problems with deciding employment status
The report’s conclusion is that not only is there a problem, but it’s growing, too. A key issue for businesses and individuals affected is the lack of certainty of the individuals status (with case law continuing to evolve in different directions, including from the European Union).
Uncertainty in establishing employment status generates problems for businesses who hire (the engagers), intermediaries (Umbrella companies and recruitment agencies) and the individuals they use, when the individual is clearly not an employee, because of the:
- Perceived or actual complexity of establishing the correct status of an individual
- Administrative cost of determining the correct status
- The cost of establishing and running structures to limit risk
- The cost of unexpected tax liabilities and penalties for making incorrect decisions about status (including employment tribunal decisions/costs)
A recurring theme in their consultation meetings was the issue of whose job it is to prove the employment status of an individual. HMRC have an online Employment Status Indicator Tool, which is voluntary to use, but which many believe to be biased to finding that an individual is an employee.
The Report considered at length what HMRC can help with and what they can offer, as well as their experiences. Currently, HMRC offer guidance on employment status in various ways, including their Employment Status Manual, but general feedback to OTS was that information on the HRMC website:
- Wasn’t well signposted or easy to find
- Needs more clarity and was out of date with developments in working practices
- Requires background knowledge of the area and so isn’t easily accessible to the layperson
One of the report’s recommendations was that all relevant HMRC material should be brought together in some form of online ‘employment status portal’ covering both tax and employment rights.
Whose job is it to prove employment status?
Currently, businesses believe the onus is on them, which can lead to a tendency to ‘solve’ the situation by hiring people only through an intermediary (such as an umbrella company) to avoid problems.
The consensus is that the classification of an individual’s status is a choice, which is incorrect, as it’s a mixed question of fact and law (with case law going back many years), that’s ultimately for the courts to decide upon. Unfortunately, over the years, Courts have proposed various tests to determine status, but still there’s no one single test.
The status question is further complicated by the fact that an individual’s status may change over time – if a project with the hirer changes the nature of the relationship may change.
There’s not a high level of knowledge of status issues within organisations, and so little understanding of what could happen if a worker’s employment status is classified incorrectly.
There are difficulties around making small payments to individuals (e.g. £50 for running a one-day workshop or engaging a driver for one day). If these payments are infrequent, it’s an administrative burden to process the income via payroll.
This last issue led to discussion about whether there could be a ‘de minimis’ level of payment for which the engaging business could engage the individual to provide services but wouldn’t need to consider employment status or payroll obligations – which is like the ‘seven day’ rule operated in the Film and TV Industry.
Several legal commentators the OTS interviewed thought, quite rightly, that as soon as one case establishes a legal point, the next Tribunal will have different facts, so there’s no consistency or certainty.
In addition, the HMRC have agreed a number of concessions in certain occupations that vary the general rule on employment status. The OTS recommends a review into these industry-specific regulations with a view to their abolition and to have a single set of rules that are publicised and fair to all tax payers.
The OTS’ view
Clearly, interpreting the law on employment status isn’t easy and the OTS felt that what is clear is that, as a whole, the body of case law looks like a mess! But they believe that, if taken apart, it does make some sense, and so considered the use of a Statutory Employment Test.
The OTS recommend that there’s a joint review between HMRC, The Treasury, the Department for Work and Pensions and BIS which looks at the possibility of developing an agreed code of principles on employment status. With work to develop better guidance for the average individual and small business, on the rules of employment status (with the documentation and actions that HMRC would expect to see a business take when engaging a self-employed individual – e.g. “what good looks like”).
The Report acknowledged that the overriding aim must be to develop ideas that lead to simpler rules that can be easily applied in practice and which are easy to enforce.
Direct routes to improve the current situation
The Employment Status Indicator Tool from the HMRC
The OTS considered how efficient the existing tool is at determining employment status. It can’t be used for Personal Service Companies, agency workers, workers in the film & TV industry, or ‘office holders’.
The tool is currently anonymous and voluntary, and provides an indication of status of whether someone is employed, self-employed or ‘not determined’ – as long as the answers to the questions accurately reflect the Terms and Conditions under which the worker provides their service.
The OTS found that professional advisors tend to go through their own set of questions and investigations; some perhaps checking the position on the HMRC tool for completeness. Many businesses, advisors and professional bodies felt that HMRC’s tool could be easily manipulated, but also the questions could be misinterpreted and to use the tool properly required a reasonable background knowledge of employment status issues.
Many choose not to use it or don’t even know it exists.
HMRC say their tool is based on case law (and five main factors are included – control, substitution, financial risk, business structure and integration). The OTS believe HMRC should review and update the case law underpinning their tool and it should reflect modern working relationships and arrangements.
The Statutory Employment Test
The idea for a statutory employment test aroused a lot of interest, as it would lay down rules in statute to determine employment status, which would apply to all taxes (income tax, NIC’s and VAT).
This could either be a detailed approach (a complete set of rules reflecting all aspects of relevant, current law) or a simple approach (a short set of quantitative tests that are easy to deal with).
Another option would be to develop a ‘de minimis’ (or ‘minimax’) approach. So, working for an organisation for more than X months continually would mean you’re automatically an employee and working for fewer than X days/weeks for an organisation means you can’t be an employee. The test could also apply to the amount of income earned from the hirer.
The OTS believe a ‘de minimis’ approach would help businesses by having a principle that someone who’s paid under a set amount or works for less than a defined period wouldn’t be regarded as an employee. They acknowledged the risks in this, that legislation would need to be drafted so that individuals couldn’t receive a series of payments below the ‘de minimis’ level, under separate contracts, that were in reality connected and continuous.
Contractor groups believe this would lead to unscrupulous employers offering assignments only that fit within these parameters, and that any anti-avoidance measures put in place would be unlikely to work adequately. Another concern contractor bodies may hold includes how this would work with existing legislation, i.e. the Agency Workers Regulations.
Indirect routes to improve the current situation
Tax and National Insurance differences
The differences between Income Tax and NIC’s are a major driver for the problems around employment status. However, fixing these differences wouldn’t solve an employment status dispute; but it would reduce the amounts of money at stake and so make arguments much less likely.
The OTS believe that if you remove the differential between tax and NIC rates and treatments this would reduce the incentive to ‘distort’ status and simplify the system for taxpayers, employers’ payroll administration and for HMRC. This idea isn’t new but hasn’t yet been acted on.
Deduction of tax at source
Payments to the self-employed are obviously not subject to any deduction of tax at source (apart from under the Construction Industry Scheme). During discussions the idea of changing this and ‘withholding’ tax on payments to at least some non-employees was popular.
The OTS believe such a system would have merits and is worth examining more. This system would provide an additional administrative burden to businesses but they would know they’ve complied with the law.
A Third Way
The report remarks that the tax system is stuck in an old-fashioned mindset of categorising workers as either PAYE employees or self-employed, which doesn’t take into account the huge growth in freelancing as a way of life.
So, the tax system may need to recognise a ‘third way’ of working, which would be a status between employed and self-employed, which has it’s own modified set of tax rules.
The objectives of setting up a ‘third way’ would be to:
- Resolve or avoid arguments
- Provide a certain status and set of tax rules
- Reduce administrative burdens all round
There are two routes to develop this:
- A new type of legal entity is created for the individual who operates in this manner
- A new status is accepted (with appropriate employment rights and tax, NIC and VAT arrangements)
The ‘third way’ could be a ‘single person limited company’ or a new ‘freelancer limited company’. It is already possible to establish a third way by operating through a Personal Service Company, but this isn’t formalised as a status.
Formalising a new status would give a clear result in tax terms and ideally avoid IR35 arguments. The OTS commented that this route is only worthwhile if IR35 can be abolished in the process – however, they’re not convinced this route is the best way forward, as it only adds complexity to the tax system.
So, we wait to see what the next government will pick up from this report and where it may lead! The government, in November 2015, have said they’ll take forward the majority of the report’s recommendations; we wait to see what this actually means, but we understand that the government accept that the HMRC should issue best practice guidance on what to do when engaging a self-employed individual and the HMRC should set up an employment status helpline and upgrade their status indicator tool. They have rejected introducing a de minimis level of remuneration before needing to consider employment status
If you are an Employer and need ongoing professional help with any staff/freelance issues, or a Contractor/Freelancer/Employee with a complicated employment related problem, then talk to Lesley at The HR Kiosk – a Human Resources Consultancy for small businesses – our fees are low to reflect the pressures on small businesses and you can hire us for as much time as you need.
Please note that the advice given on this website and by our Advisors is guidance only and cannot be taken as an authoritative or current interpretation of the law. It can also not be seen as specific advice for individual cases. Please also note that there are differences in legislation in Northern Ireland.