Every now and then you may find that you need additional skills to successfully fulfil the requirements of a project. This means you may need to bring in a third party to assist you. However, in doing so you open yourself up to some potential tax and legal pitfalls surrounding the status of the engaged party are they an independent contractor or an employee?
What is the difference, and why is it so important?
First of all, the easiest option from the engagers point of view is to contract a limited company. You, as the engager, do not need to worry about the employment status of the limited company you are subcontracting work to, they are simply subcontractors in your accounts and thats your admin finished. They might have IR35 considerations if the work involved would otherwise be considered that of an employee, but the need to identify this falls on them if they incorrectly apply the IR35 legislation. This is why many larger companies will only subcontract work out to limited companies it makes their administration safer and easier.
If you subcontract work to an individual then you need to pay much closer attention to their employment status. If you incorrectly determine they are a sole-trading independent contractor and HMRC (or the courts) deem that their work undertaken is in fact that of an employee, then it is your responsibility as the engager to pay the unpaid PAYE and NI. In addition there may also be late payment fines and fines for incorrect submission of PAYE returns.
How do you determine the status of an employee?
HMRC have given some guidance on this, but it is still a case-by-case decision and employment status cases still regularly reach the courts to decide the outcome.
Essentially it all comes down to the definition of the contract - is it a contract of service (employee) or a contract for services (self-employed, independent contractor)? The actual name of the contract is not important here, it is the reality of the situation (similar to IR35).
If the answer to all the following questions is Yes then the worker is probably an employee:
- Do they have to do the work themselves?
- Can someone tell them at any time what to do, where to carry out the work or when and how to do it?
- Can they work a set amount of hours?
- Can someone move them from task to task?
- Are they paid by the hour, week or month?
- Can they get overtime pay or bonus payment?
If the answer to all the following questions is Yes it will usually mean that the worker is self-employed:
- Can they hire someone to do the work or engage helpers at their own expense?
- Do they risk their own money?
- Do they provide the main items of equipment they need to do their job, not just the small tools that many employees provide for themselves?
- Do they agree to do a job for a fixed price regardless of how long the job may take?
- Can they decide what work to do, how and when to do the work and where to provide the services?
- Do they regularly work for a number of different people?
- Do they have to correct unsatisfactory work in their own time and at their own expense?
Find out more about employment status
Whether an individual is an employee or a self-employed independent contractor not only determines how tax is applied, but also relates to the various rights that employees have that contractors dont. This is a legal definition that is based on a large number of legal cases and is always being updated. Its not a definition set by HMRC, they only provide guidance.
Be warned - getting this wrong can be very costly to your business both in tax/fines and legal fees.