Outside the relatively small world of the “gig” economy (i.e. companies who have built their businesses entirely around a particular staffing model), we have seen a growing trend of mainstream businesses moving towards a more “mixed” and “contingent” workforce.
The traditional employee workforce – where the main issues of status tend to be whether someone is part-time or full-time, or permanent or temporary – is in decline. Whilst the model offers simplicity in that all of the workforce are taxed in the same way and enjoy the same set of employment rights, it does not offer the desired level of flexibility.
In contrast, the mixed workforce may comprise a variety of different categories: employees, workers (perhaps on zero-hour or annualised hour contracts), self-employed individuals, or contractors who are engaged by third parties, either on an outsourced basis or using the third party as an intermediary.
The so-called contingent element refers to the use of flexible staff, typically agency workers, directly engaged zero-hours workers, or self-employed individuals. In the UK, approximately 4.8 million people now consider themselves to be self-employed, which equates to around 15% of the workforce.
Flexibility of this type adds complexity to the governance and management of the workforce in a number of areas, particularly as the legal tests to determine employment status and tax status can differ.
Correctly identifying an individual as an employee, worker or self-employed is in some cases difficult. The legal tests are complex; no one factor is necessarily determinative; and each new case in the Courts can appear to take a different approach. But the distinction is important in terms of the rights that individuals enjoy.
Employment status is determined through a matrix of tangible and intangible factors that need to be analysed in the round. The Courts will often “look through” the documents to get to the reality. Relying solely on standard template documents can lead to errors regarding a person’s proper status.
Worker or self-employed?
Looking back only 10 years or so, the more common issue was whether an individual could establish “full” employee status. The focus has now shifted to the boundary between being self-employed and being a worker, perhaps reflecting social and economic trends that accept greater flexibility in working arrangements.
The key factor to have emerged is that, in order to establish self-employed status, an individual needs to show that they are genuinely in business on their own account i.e. running a business, looking to attract a variety clients and grow revenue from different sources. An individual who works for one organisation and has no intention of building a business will not pass the test, no matter what the documents say that govern their relationship with the end client. In the gig economy cases, an important factor against self-employment is that such individuals have no economic or contractual relationship with clients or users of the service (e.g. the Uber customer, or the company sending a courier package).
Along the way, the Courts have considered whether other common features can be indicators of self-employment:
- substitution rights: these will only be taken into account if they are unrestricted in terms of when they can be used and the identity of the substitute. A right to send along a colleague to cover a job or a shift, or that gives the end client an absolute right of veto, is not a genuine substitution right;
- mutuality of obligation: in other words, does the business have to offer work, and does the worker have to do it? In many of the recent cases, the Courts have found that workers are under an obligation to work (albeit perhaps just during periods when they are logged on to the employer’s app or platform) and therefore are not self-employed;
- control/integration: workers who are centrally controlled, or subject to conduct rules or uniform requirements, have been found not to be genuinely self-employed.
Although we now have much guidance on the legal distinction between worker and self-employed status, an indirect consequence of all of the litigation in that area is that the legal distinction between an employee and a worker is arguably less clear than ever.
The UK government recently promised to introduce new legislation to clarify the boundaries between employee, worker and self-employed status. Achieving that aim will be difficult and will give businesses a new set of tests to negotiate.
It has also promised to implement the default worker status proposed by the Taylor Review of Modern Working Practices. This would automatically give some individuals, who may have traditionally considered themselves to be self-employed, worker status. The onus would then be on the parties to demonstrate self-employment for legal or tax purposes.
Direct engagement of staff
Because employees and workers are both subject to PAYE, the key issue in relation to tax is whether an individual is an employee/worker on the one hand, or genuinely self-employed on the other. The elephant in the room in many discussions, and indeed Court decisions, about employment status is the employer’s NIC charge. Arguably, a business could achieve all the flexibility it needs using employees and workers of different types, without the need to engage individuals on a self-employed basis. But that of course adds to the cost, most directly via the liability to pay employer’s NICs, but also by having to provide holiday pay and other worker rights.
HMRC’s approach to employment status is multi-factorial: it will look at numerous factors and may regard any of them, or a combination of them, as determinative. Because it is making a determination only for tax purposes, it will not necessarily follow the same approach as the Courts.
To assist businesses, HMRC created its own online employment status tool, CEST (Check Employment Status for Tax). CEST is useful but not wholly reliable: it works on relatively basic and limited information that is input by the user and therefore cannot guarantee to produce a result that corresponds to how HMRC would determine a case following detailed investigation.
Engaging staff via intermediaries – IR35 developments
An arrangement in which an individual engages with an end client via an intermediary – whether a personal service company (PSC) or some other vehicle – is increasingly likely to be scrutinised by HMRC’s anti-avoidance unit. The number of investigations into such arrangements has increased enormously in recent years as HMRC seeks to recover billions of pounds in allegedly unpaid tax.
Despite the introduction in the last few years of measures to reduce the advantages of contracting via an intermediary, using a PSC can still offer significant tax benefits for an individual: they may structure their income to be paid as dividends instead of earnings, and the PSC gets an allowance against employer NICs.
However, they will lose most of the benefits if HMRC determines that their relationship with the end client would – if the PSC was removed from the arrangement – be an employment relationship. The difficulty in practice is that no one test is determinative of this: again, HMRC takes a multi-factorial approach and the cases have turned on a variety of factors, such as the degree of direction or control, the right to send a substitute, the sharing of financial risk, and the degree of integration with the rest of the end client’s workforce.
Off-payroll working rules
From the end client’s perspective, engaging a self-employed individual via an intermediary has been more attractive than direct engagement because the intermediary is responsible for the tax. However, HMRC’s off-payroll working rules change the position enormously. They have applied in the public sector since 2017 and will apply to medium and large companies in the private sector from April 2020.
The rules dramatically alter the balance of risk as they make the end client responsible for determining the correct tax status of the intermediary. So, by way of example, if ACME plc contracts with John Smith Limited to provide the services of an individual, John Smith, ACME becomes responsible for:
- determining whether John Smith Limited falls inside or outside IR35; and
- if the determination is incorrect, potentially PAYE deductions on sums paid to John Smith Limited.
ACME may escape or reduce its exposure if it makes a reasonable and good faith attempt at determining the tax status, but the new rules still make the prospect of contracting via intermediaries much less attractive. Determinations of this type will require detailed knowledge of the off-payroll rules and the law on employment status. HMRC has promised to introduce an improved version of the CEST tool to assist but, as with many online resources, it will never be a complete substitute for human judgement and expertise.
We predict that the extension of the off-payroll working rules to the private sector will change the dynamics of the recruitment market in that sector. High-value, in-demand individuals with unique expertise will no doubt have the commercial leverage to be able to insist on continuing to contract via PSCs or other intermediaries. But the new rules will make it unattractive for end clients to engage in this way on a volume basis, or in cases where the value is outweighed by the risk.
Pushing the financial risk down the chain to the intermediary or the individual through contractual indemnities and other mechanisms is already common, but is not a failsafe and can leave end clients exposed. In addition, organisations will face the reputational risk of being found to be in breach of the rules.
New models of engagement will undoubtedly emerge in response, for example:
- outsourcing arrangementse. where the intermediary offers to provide the service of an individual or group of individuals on an outsourced basis. This could be attractive in some respects, but with outsourcing comes all sorts of other legal and commercial issues, such as risk allocation, pricing, termination rights and the impact of the TUPE Regulations;
- umbrella company arrangements – these offer the relative “comfort” of providing the services of on-payroll individuals. However, the market is relatively unregulated and can harbor structures that are aggressive from a tax perspective and which still entail risk for the end client.
New models will present a new learning curve for end clients.
Future management and planning
Leaving aside the issue of whether individuals genuinely choose flexible working arrangements, or just have no other option, evidence suggests that any mixed workforce presents a variety of concerns and expectations.
Zero-hours workers and self-employed individuals have concerns about lack of benefits, such as sick pay and pension contributions, and lack of training and career development opportunities. They perceive that full-timers are treated better and are more highly valued. They resent not being integrated as much into the organisation (and of course this may be a deliberate strategy by the end client who is keen to maintain a distinction between them and true employees).
On the other side of the fence, there is a perception amongst some employers that permanent employees are more committed and provide better overall value than “contingent” resources.
In the past, legislation has been used to try to equalise the rights of part-time and full-time staff, but the employment status landscape is now much more complex and the existing legislation is often of limited relevance.
Managing a mixed workforce with different sets of rights, tax obligations and statuses means a whole host of different practical issues, from managing different holiday rights to taking different approaches to conduct and performance issues and balancing different degrees and strands of integration. This requires investment in sophisticated and agile support, whether HR or legal, with the business systems to support it.
Addressing the existing complexity and future change requires a degree of planning:
- lead-in time – planning for the change to legislation involving employment status or off-payroll working is important because of the lead-in time required to make changes. The introduction of the off-payroll working rules in the public sector was rapid, forcing many end clients into making blanket decisions about the use of self-employed contractors, rather than considering cases individually. In the private sector, a medium or large company that wants to retain, after April 2020, a valued individual who contracts via a PSC, will either need to be prepared to make a determination about tax status, or have agreed with the individual a new form of engagement that avoids the off-payroll working rules.
- risk analysis – organisations need to understand the issues in order to analyse the risk. They may have engagements that are, or have become, risky e.g.:
- a directly engaged “self-employed consultant” who has been working for the organisation on a continuing basis for an extended period;
- a zero-hours worker who is routinely rostered onto shifts alongside employees, without any obvious offer or acceptance of work; or
- an IR35 contractor who has become an integral part of the workforce.
documentation – whilst not conclusive in employment status or IR35 cases, using well-prepared documentation can minimise the risk of mis-labelling, and could be evidence that the business has made reasonable efforts to make a correct determination about status. No matter how “sophisticated” they are, documents that describe a status or arrangements that do not correspond to reality will be of little value in a dispute or investigation.
|HMRC's online tool: Check Employment Status for Tax
|The organisation that wishes to engage an individual (either directly or through an intermediary).
|A catch-all term for the various pieces of legislation and HMRC rules that govern the engagement of individuals via intermediaries.
|The arrangement does not satisfy the HMRC test of self-employment. As a result, the individual is deemed for tax purposes to be an employee. The earnings that the individual receives from the engagement will be subject to income tax on a deemed amount.
|The arrangement satisfies HMRC's test of self-employment and the individual is deemed to be a genuinely self-employed contractor operating through an intermediary.
The individual may enjoy significant tax advantages.
|A catch-all term for working arrangements that are not subject to PAYE.
|Off-payroll working rules
|The IR35 rules generally, but specifically the obligation on the engager end-client to make a determination about the tax status of the intermediary.
This obligation already applies to public sector organisations and will apply to private sector businesses from April 2020.
|Personal service company: a limited company set up by an individual through which they provides their own services.
|A third party vehicle set up to act as the employer of a large number of individual contractors.