Dealing with self employed contractors – advice for employers and end users
In the drive to cut down on costs it is tempting to engage workers as self-employed and skip signing contracts. However, we commonly deal with cases where this temptation has left employers with a:-
• Unplanned income tax and national insurance liability on payments made to the contractor;
• Employment law liabilities;
• No means of protecting intellectual property such as the client base and know how;
• Feeling disappointed as the situation may be avoidable.
Read on, and avoid these traps.
Background to engaging self-employed workers
Engaging workers on a self-employed basis is undoubtedly an attractive option for businesses. There’s no obligation to provide statutory employment benefits, contractors have limited protection under employment protection legislation, making it easier to hire and fire to suit changing business needs and, best of all, historically there is a saving of employer’s NI contributions.
The benefits are such that many employers are tempted to engage workers as contractors, where it’s far from clear that they are genuinely self-employed for tax purposes and or employment law purposes. If there is no contract in place the workers can and will be tempted to walk off with intellectual property such as customers, employees, know-how and source code plus anything else they fancy and there will be little the employer can do to stop this in practice.
However, where self-employed status is questionable, the risk of significant liability being incurred is much greater than commonly appreciated, particularly in respect of tax liabilities.
Risks of engaging self-employed workers
There is always the risk that a worker’s employment status being challenged for tax purposes. HMRC can do so off its own bat as part of a PAYE audit or random enquiry. However, the powers of HMRC will increase shortly.
HMRC does not wish to abolish IR35. Instead it wishes to introduce changes which will bolster its powers. HMRC wants contractors to be taxed as if they were employees and for PAYE to be operated. HMRC no doubt see the end user who now becomes in effect the employer as a more expedient tax collection mechanism than the contractors.
The end user will have the obligation to operate IR35 on behalf of individual contractors operating via personal service companies. This means that it will be the end users who will carry the administrative burden of complying with IR35 and who will be exposed to investigations by HMRC seeking to collect income tax and national insurance under PAYE. The ambit of IR35 is to be extended to bring more self-employed contractors within its range.
Employment law risks to be avoided
There is an added risk that the worker will seek to establish that they have in fact been employed, with this coming to the attention of HMRC. Alternatively, we do deal with cases where the workers accept they started off as self-employed but moved into an employed position as they became more established within the business. Such claims are often made if the worker has not paid his tax on a self-employed basis and is looking to the employer for payment. Another common risk area is where a worker may have accepted being required to work on a self-employed basis initially (they may be paid more, can deduct expenses against income and are otherwise willing to accept the arrangement so they get the work) if their contract is terminated they may well be disgruntled and seek redress.
This will usually involve the worker arguing that they have been employed so they can go to the employment tribunal to bring claims such as unfair dismissal and claim the tax should have been paid on their behalf by the employer. In dealing with a defence your position will be much stronger if the contractual agreement is signed and fit for purpose.
Tax and cost exposure
Should an employment tribunal decide that the worker was in fact employed, it would be foolhardy to believe that HMRC could be persuaded otherwise, or to believe that HMRC won’t ever become aware of the ruling itself. Tax liabilities now incurred could well dwarf any employment tribunal award to the worker.
In the first instance, credit will not necessarily be given for income tax/NI paid by the worker under self-assessment, if HMRC takes the view that the business engaged people on a self-employed basis to take advantage of this dispensation. This means that the business could have to account for all the amounts that should have been deducted under PAYE, even if the worker has also paid income tax under self-assessment.
Even if income tax/NI paid by the worker can be set off against the business’ tax liability, it will still be subject to penalties for failing to operate PAYE/make NI contributions. Penalties for lodging inaccurate PAYE/NI returns are calculated as a percentage of the total amounts that should have been paid for up to six years, without any account being tax/NI paid by the worker under self – assessment during this period.
The percentages payable as penalties range from up to 30% where the failure to make payment was down to carelessness, up to 70% where the failure has been deliberate but not concealed and up to 100% where the failure has been deliberate and concealed.
Example: engaging self-employed workers
If a business paid someone they thought was a contractor £100,000 gross of tax thinking that the worker would be responsible for declaring and reporting the tax to HMRC but that that tax is not paid the employer could face a tax bill assuming a rate of income tax of 40% as follows:
Cost: £100,000 plus tax £97,643 = £197,643
Cost of wages: £100,000
Tax due on wages: @ 40% £40,000
Grossed-up from tax due: 40,000 x 100/(100-40) £66,666
Total value plus tax payable: £166,666
National insurance – employers and employees class 1: £30,977
Total due to HMRC: £66,666 + £30,977= £97,643
This does not take account of interest and penalties payable for the late payment of tax under PAYE
Where the business has (deliberately) chosen to engage individuals on a self-employed basis, then it can only be envisaged that the penalties will be higher up the scale. The business will also be liable for interest and late payment penalties.
Tax liabilities for one highly paid contractor engaged for a number of years could easily run into tens of thousands of pounds. Where a business engages a number of contractors, all of whom are deemed to be employed. Where one is decided to be an employee, arrangements with all contractors will come under scrutiny. The tax liabilities could destroy the business.
Summary: engaging self-employed contractors
In the round, engaging individuals directly as self-employed contractors who could well be decided to be employees simply isn’t worth the risk without taking advice to identify other available options to control staffing costs/reduce tax liability and maintain flexibility. The employer will always be in a better position if there is an intermediary, aligned with signed contracts in place between them and their contractors setting out the intended status and protecting the business assets by way of restrictions on competitive behaviour, protecting fully confidential information and restricting activities to protect intellectual property.
Thank you for reading our Article on advice and risks in hiring contractors direct. Job-Drop: The Contractors Platform allows your business to hire contractors efficiently, with all the benefits of hiring direct - without the risks. Contact our team here for more information.
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