Employment and Self-Employment
A quick look into the complicated and increasingly fuzzy differences between employment and self-employment.
The tax position
Overall, the self-employed enjoy tax advantages compared to their employed colleagues.
- A self-employed worker pays lower rates of national insurance (at the time of writing: 9%, or 2% on earnings above £46,350).
- There is no benefit in kind tax on private use of business vehicles.
- Expenses which are wholly and exclusively for the purposes of business can be claimed as deductions against taxable profits, while employee expenses adds a further condition before they can be claimed – expenses must be wholly, exclusively and necessarily incurred in the course of their employment.
- Self-employed workers also have the cashflow advantage of paying tax due on their earnings in the tax year ending on 5 April in two instalments at the end of the succeeding July and January. Employees have tax deducted from their earnings when it is paid.
- Self-employed workers often have the option to direct the profits of their business to limited companies, which can have significant tax benefits.
- Self-employed workers can pay salaries to family members, reducing their own taxable profits, and utilising the family member’s tax-free personal allowance. The salary must be paid on a genuine commercial basis for actual services provided and must actually be paid. Employees would have no such flexibility.
However, the self-employed must go through the bureaucracy of completing a self-assessment tax return. In general, and with many exceptions, employees earning less than £100,000 do not need to complete a return.
What about the employer?
Hiring a self-employed worker rather than an employee has advantages to the employer too: –
- Employers pay employer’s national insurance contributions (currently 13.8% of gross earnings) and pension contributions (currently 1%) for most employees
- In theory, self-employed contractors have little or no employment rights in matters such as sick pay, paid holiday leave and parental or maternity pay.
Recent supreme court judgements concerning section 230 of the Employment Rights Act 1996 seems to grant protected “worker” status to the self-employed where “an individual undertakes to do or perform personally any work or services” including whistle-blower and unfair dismissal protections. This creates a fuzziness between
Self-employed workers (other than those who trade through limited companies) are in business on their own account. The law does not distinguish between a creditor’s claims on their private and personal assets.
Self-employed contractors’ employment rights are curtailed as set out above.
However, employees also face significant risks. They may lawfully be made redundant with only a small entitlement to statutory redundancy pay if their employer’s business requires it.
Is self-employment a choice?
The courts have been consistently clear that merely signing a contract that states that an employee is self-employed does not automatically render that employee self-employed if the substantive relationship is one of employment. The following factors are relevant to determining whether a relationship constitutes employment or self-employment
- Mutuality of obligation. This refers to the obligation of an employer to provide work and pay for it, and the corresponding obligation of the employee to personally do the work. However, the use of zero hour contracts, whose classification as employment has never been subject to doubt, does challenge this notion.
- A line managed worker carrying out a regimented task – particularly one carried out simultaneously by other workers such as a warehouse packer – is unlikely to be classified as self-employed. Skilled employees such as software developers enjoying substantial independence in carrying out their jobs are more likely to be construed as self-employed.
- Set hours and a set place of work are associated with employment.
- The right of substitution rather than a requirement of a worker personally carrying out work is a valuable indication of employment. HMRC have recently lost a case in which they sought to assert an employment relationship predicated mainly on a lack of right of substitution.
- Typical commercial arrangements such as the worker using their own tools, having multiple clients, and especially no one predominant clients, marketing their services widely, or obtaining their own insurance are indicators of self-employment.
Despite decades of different cases, exactly how these different factors are to be weighted is unclear. Recently a number of examples have arisen of workers being granted employment rights while taxed as self-employed, which makes for a very confusing position for businesses looking to comply with the law.
Limited companies and LLPs
It used to be the case that using specific legal intermediaries – such as LLPs or companies – would make what would otherwise be an employment relationship into a contractor or self-employed relationship.
Members of LLPs are now taxed as employees unless they substantially participate in the risks, decision making, and rewards of the LLP’s trade.
Companies which provide services on what would otherwise be a contract of employment are required to pay tax as though they were an employee under the “IR35” rules. Exactly which types of relationship are caught under these rules is a complex and still evolving area of law.