Employment status is at the centre of both employment law and PAYE and it determines the employment rights that an individual is entitled to receive, and the tax and National Insurance contributions (NICs) that they and the business they undertake work for must pay. HM Revenue & Customs (HMRC) collected £819 million in additional tax revenue through payroll investigations in 2016/17, as it continued to deal severely with organisations that wrongly classify workers as self-employed. Paul Tew, small business consultant and freelance advisor, looks at how the current employment status framework works and what this means for businesses and individuals.

Employment status is the classification of a working relationship between a person providing work and a person carrying out that work. However, determination of an individual’s status is not just a matter of what the contract says, it is the underlying reality of the facts of the engagement, of which a written contract is one aspect. Stating one thing in writing but doing something different in practice creates a false employment status.

Employees receive a full range of employment rights, although certain significant rights, eg unfair dismissal only apply after a minimum period of service. Workers are entitled to fewer rights, all of which apply from the start of the employment. Self-employed individuals generally receive no employment rights as they are in business for themselves and providing a service to a client. A contractor or freelancer could be entitled to the rights associated with any of the three statuses. Even if an individual knows their status for employment rights, that does not necessarily tell them what their status for tax should be, or vice versa. For tax and National Insurance (NI) individuals are generally either employees or self-employed.

Both the cost to business in providing employment rights and the requirement to pay employer NI generally makes it cheaper to engage individuals on a self-employed basis, rather than as an employee or as a worker. However, an engager cannot mutually agree with an individual to be self-employed, simply to reduce administrative burdens and costs.

How the law is applied

The law defining employee for both tax and employment rights relies on whether a contract of service exists. No further definition or clarity is provided so the law courts have interpreted the legislation and developed tests to determine an individual’s employment status. To add to the uncertainty around employment status case law is constantly evolving as new cases and appeals are heard and new precedents are set.

The three current main tests are the following.

  1. Mutuality of obligation — the obligation to provide work, or to pay for work done, and the individual’s obligation to perform that work. It can be difficult to be sure of mutuality of obligation in atypical or casual working arrangements where there is no obligation to accept work or to have work offered.

  2. Control — whether control by the engager, or the right to control exists over the individual. Establishing if control is present in a working arrangement is increasingly shifting away from whether there is day-to-day supervision over the worker, and now tends to focus more on the right to control, even if that right is not exercised on a regular basis.

  3. Personal service — requires the individual to personally provide services to an engager. The courts have established that where an individual is able to send someone else to perform their duties, this will be inconsistent with personal service, except in limited circumstances, eg the right is only exercisable in the event of illness. A genuinely unlimited right to delegate the work to someone else will most likely mean that the individual is not an employee.

There is no formula that the courts will use to determine if the tests are met. The weighting of each factor varies depending on the working relationship and is a judgment based on the whole picture. There is no tick-list or prescribed list of factors that the courts look at when considering this wider picture. The presence of a factor is not conclusive proof of a person’s status, but it may act as a strong pointer. For example, the greater the financial risk the individual has, the more likely is he or she is self-employed.

The emergence of the gig economy, where digitalisation is used to allocate work, means that the tests developed decades ago cannot be easily applied to these new arrangements. In the gig economy, it is relatively straightforward to argue that individuals are not employees as companies tend not to exert sufficient control over the work and there is often a lack of mutuality of obligation between the parties. It is far harder to decide whether these individuals are workers or self-employed, although recent case law has erred on the side of worker status.

Where employment status is disputed

Individuals in regular, standard, permanent work arrangements do not often dispute their employment status. However, for engagers using people to perform work who have atypical or non-standard work arrangements it may be unclear what their employment status is. This is because the above-mentioned tests are more difficult to apply.

Where an individual’s employment status is in dispute it can only be resolved by a court. For employment rights, a dispute is first heard at the employment tribunal who make decisions on employment status by looking at how the relationship between the person and the business works in practice. The outcome of such a court case will only be binding on that case, not to other individuals working for the same employer under a similar arrangement.

HMRC also carries out enforcement activity to ensure correct employment status tax determinations are being reached. The first stage in a case would usually be HMRC deciding an individual’s employment status and raising a tax assessment on that basis. That decision would generally be subject to appeal.

This all can make resolving employment status cases complex and time consuming, increasing costs for business.

Four tips for establishing employment status

  1. Engagers can check if a worker should pay tax through PAYE for an engagement by using HMRC’s online service. This works by asking a series of questions, the answers of which should best match the usual working practices of the engagement. HMRC will stand by the result given unless a compliance check finds the information provided is not accurate.

  2. If the result is indeterminate, then more information will be needed to better understand the working practices of the engagement. In cases of doubt, then consulting appropriate employment lawyers and tax consultants may provide a solid legal footing for the status you use to offer employment rights and process payments.

  3. Review all current contractual arrangements in place and make sure that the wording reflects the true reality of the working relationship and this can be substantiated by records and actions of the parties involved.

  4. If following the review, you decide that it is necessary to make changes to the deemed status of the person performing work on your behalf, then this should be communicated to the individual at the earliest opportunity, together with an explanation of how this recategorisation will affect his or her employment rights and level of payments made.

Last reviewed 15 May 2018