1. finance
2. personal finance
3. financial planning
4. retirement and pension

EMPLOYMENT
STATUS: WHY
IT MATTERS
AND HOW TO
TEST
TolleyGuidance
3rd October 2012
This document contains a small example of some of the material
that you will be able to find in the Employment Taxes module of
Tolley®Guidance.
All text in green bold represents links to internal and external
content which are active within the Tolley®Guidance product.
For more information or to arrange a free trial please visit
www.tolley.co.uk/guidance
TolleyGuidance
Contents:
Employment Status: Why it Matters...................................3
Employment Status Tests..................................................7
Employment Status Test Examples..................................13
Establishing Employment Status......................................14
Employment Status: 03/10/12
TolleyGuidance
Employment status: why it
matters
This note sets out the main differences
between employment and selfemployment. It discusses the timing of
payment, National Insurance
Contributions (NICs), expenses, statutory
payments, leave entitlements and (briefly)
employment rights.
From the individual's perspective
employment status matters because it
determines the tax and NICs on his
earnings, as well as his statutory rights.
From the engager's perspective,
miscategorisation may trigger PAYE and
NICs assessments as well as claims for
employment rights or statutory payments.
Getting employment status wrong can be
very expensive.
Remember that this note, and the other
notes on employment status, are only a
summary and do not cover all situations.
You may need to take further advice. For
the position of those working through
personal service companies and the IR35
rules, see the Personal service
companies overview guidance note.
The rates and allowances used in this
note are those for 2012/13.
Gross or net
The first difference between employment
and self-employment is that employees
have PAYE and NICs deducted from their
general earnings before receipt, whereas
the self-employed are paid gross.
ITEPA 2003, s 684
Employment Status: 03/10/12
Income Tax (Pay As You Earn
Regulations) SI 2003/2682, Reg 21
Social Security (Contributions)
Regulations SI 2001/1004, Reg 67
The self-employed pay their tax and Class
4 NICs on 31 January following the end of
the tax year, and make a payment on
account of next year's earnings at the
same time. This pattern of payment is
generally beneficial, giving the selfemployed a cash-flow advantage over
employees.
Rates and structure of NICs
The self-employed pay significantly lower
NICs compared to the total NICs burden
imposed on employees and employers.
The self-employed
Once their profit is at least £5,595, the
self-employed pay Class 2 NICs at a flat
rate of £2.65 per week. Class 2 NICs give
entitlement to 'qualifying years' for the
basic state pension and an entitlement to
maternity allowance and bereavement
benefit.
SSCBA 1992, s 21
The table on the DirectGov website
provides a list of benefit entitlements.
The self-employed also pay Class 4 NICs
at 9% on profits between £7,605 and
£42,475 and at 2% after that. Payment of
Class 4 NICs does not provide any benefit
entitlements. The limits and tables for
current and recent years can be found on
the HMRC website.
TolleyGuidance
The employed
Employees pay 12% NICs on earnings
between £7,605 and £42,475pa and 2%
above that threshold. Employers pay
13.8% on all earnings above £7,488 pa,
with no cap. As employee NICs are
normally calculated on a weekly or
monthly earnings period basis (rather than
annually), the actual liability can vary. For
more on earnings periods, see Tolley's
Practical NIC Service 2011/12 Chapter 34.
Both employer and employee
contributions are categorised as Class 1;
payment of Class 1 employee
contributions entitles employees to a wider
range of benefits than Class 2. See the
table on the DirectGov website for the list
of benefit entitlements and the HMRC
website for current and recent rates and
thresholds.
The consequence
These differentials mean that engaging a
freelance individual produces a Class 1
NIC saving of at least 15.8% (13.8% +
2%) compared with taking on an
employee - and that saving rises to 25.8%
(13.8% + 12%) if the individual earns
below £42,475, a saving of over 25% of
gross pay. That saving compares very
favourably with the NIC that the freelance
individual would pay: 9% on his profit after
all self-employment deductions plus the
£137.80 Class 2 NIC.
Expenses
Compared with employees, the selfemployed have more generous rules for
Employment Status: 03/10/12
tax-allowable expenses: they can deduct
costs incurred 'wholly and exclusively' for
the business.
ITTOIA 2005, s 34
Employees can generally only deduct
expenses 'incurred wholly, exclusively and
necessarily in the performance of the
duties', although the rules for travel
expenses are more generous.
ITEPA 2003, s 336, ss 339-42
See the Expenses guidance note for
more on the expense rules for employees,
and Trading income and expenses in
the Personal Tax module (subscription
sensitive) for the rules which apply to the
self-employed.
Statutory payments
Employees are entitled to certain 'statutory
payments': Statutory Sick Pay (SSP),
Statutory Maternity Pay (SMP), Statutory
Adoption Pay and Statutory Paternity Pay.
For most businesses statutory payments
are both a cost and an administrative
burden.
SSP and SMP are further discussed
below. For Statutory Adoption Pay and
Paternity Pay, see SPM30000 and
SPM40000 respectively.
Statutory sick pay (SSP)
If a self-employed individual falls ill, there
is no obligation on the engager to pay him.
However, a sick employee is entitled to
SSP, providing that (a) the employer has a
liability to pay secondary Class 1 NICs
and (b) the individual is incapable of work
through sickness for four or more calendar
TolleyGuidance
Employment Status: 03/10/12
days in a row. For more information, see
the Sick pay guidance note.
SSCBA 1992, Part XISPM10000
In some cases the SSP paid by the
employer can be recovered from the
government, but this only applies to high
levels of sickness absence.
SSCBA 1992, s 159A
SI 1995/512
For more on SSP, see the HMRC
helpbook E14/2012 and the HMRC
website.
Leave for employees
Employees have a legal entitlement to
certain periods of time away from the
workplace. Mothers can take up to 52
weeks of maternity leave, fathers may be
entitled to one or two weeks paternity
leave, and all employees are entitled to
'reasonable' time off to take care of
unexpected emergencies involving their
dependants.
For more information, see the 'maternity,
paternity and adoption' section of the
DWP website.
Statutory maternity pay (SMP)
If a self-employed woman becomes
pregnant and stops work, her client
normally has no continuing responsibilities
to pay her.
In contrast, employees are entitled to SMP
as long as they have been employed for at
least 26 weeks. The SMP is based on the
individual's average weekly earnings.
SPM20800
Most employers recover 92% of the cost
of SMP; small employers can recover
100%. Since SMP is itself subject to
employer's NICs, a small additional
compensatory amount is also paid to
small businesses. Information on how
much SMP can be recovered can be
found on the HMRC website. For more
information on SMP, see the Maternity
pay guidance note.
Statutory Maternity Pay (Compensation
of Employers) and Miscellaneous
Amendment Regulations, SI 1994/1882
SPM21200; SPM21300
Employment law rights and other
risks
Employers also have other employment
law burdens and risks. In particular,
employees have the right not to be unfairly
dismissed. For more about employment
law rights, see the Employment Law topic.
Employers are also vicariously liable for
the acts of their employees; this means
that, if the employee is negligent, the
employer may have to pay damages.
The 'worker' category
For tax and NICs there are only two
categories of individual - the employed
and the self-employed. However,
employment law recognises an
intermediate 'worker' category. All
employees are workers, but so too are
those who 'undertake to do or perform
personally any work or services for
another party to the contract whose status
TolleyGuidance
is not by virtue of the contract that of a
client or customer of any profession or
business undertaking carried on by the
individual.'
Employment Rights Act 1996, s 230(3);
National Minimum Wage Act 1998, s 54
Workers are entitled to be paid the
national minimum wage and holiday pay
and are subject to the Working Time
Directive. It is thus important to establish,
not only whether an individual is an
employee, but whether he is a worker. For
more information, see the Determining
employment status and National
minimum wage guidance notes.
For a recent example of a case examining
worker status, see The Hospital Medical
Group v Westwood [2012] EWCA Civ
1005, where a self-employed GP with his
own medical practice was nevertheless
found by the Court of Appeal to be a
'worker' when he performed services for
clients of the Hospital Medical Group on
their premises.
Overall position
From the engager's perspective,
employees are much more expensive than
the self-employed: NICs, statutory
payments and leave entitlements, together
with the risk of claims for negligence
liability and unfair dismissal strongly tilt the
balance in favour of self-employment.
Engagers may thus prefer to use selfemployed ('freelance') workers.
Individuals may also prefer selfemployment - they are often able
negotiate a higher rate of pay than would
be available to an employee, because of
the cost savings to the engager. However,
their perspective may change when they
Employment Status: 03/10/12
lose their job, become pregnant or have
an accident. At that point, they may seek
to claim that they were employed, and
claim unfair dismissal, maternity rights,
damages or sick pay from their engager.
HMRC is also alert to the differences
between employment and selfemployment. PAYE audit teams frequently
seek to establish whether those engaged
on a self-employed basis are, in fact selfemployed. See Establishing
employment status for more on recategorisation by HMRC.
Conclusion
If the engager is unclear about the
employment status of those working for
him, he risks employment rights claims
from the individuals, as well costly
assessments for unpaid PAYE and NICs.
The individual is also running risks. If he
should have been categorised as an
employee, HMRC may decide that the
liability for unpaid PAYE and employee
NICs can be transferred to him. If he has
an accident, falls sick, or loses his job, he
may belatedly examine his employment
status - but may of course not succeed
before the tribunal.
It is far better for both parties to
understand the position, by obtaining
advice on the implications of employment
status, at the outset.
TolleyGuidance
Employment status tests
Whether a person is employed or selfemployed has significant consequences
for tax and National Insurance
Contribution (NICs) purposes. There are
also employment law and negligence
liability implications. See the Employment
status: why it matters guidance note.
Before reading this note, you are advised
to read the Establishing employment
status guidance note, which also
discusses how to challenge an HMRC
employment status ruling in the First-tier
Tax Tribunal.
Despite the importance of the distinction
between employment and selfemployment, there is no clear definition of
what makes someone employed or selfemployed. Instead, there is an extensive
collection of court decisions. From this
case law various principles have been
established, known as status tests. This
note explains the status tests and looks at
some of the leading cases. Please note
that all cases in this guidance note are
subscription sensitive.
Remember that this note, and the other
notes on employment status, are only a
summary and you may need to take
further advice. For the position where
individuals are working through personal
service companies, see the Personal
service companies overview guidance
note.
Some engagements are classified
differently for NICs purposes. These NIC
deeming rules override the status tests.
Employment Status: 03/10/12
In business on your own account
The simplest way of deciding whether an
individual is employed or self-employed is
to answer the question: is the person in
business on his own account?
Market Investigations Ltd v The
Minister of Social Security [1969] 2 QB
173, [1968] 3 All ER 732
If an individual is running his own
business, and can demonstrate that he
has business premises (which can be part
of his home) and equipment, that he
markets his business and has a client
base, he is likely to pass this test.
However, if the individual does not have
all the trappings of a business, he can still
be self-employed. In other words, this is a
one-way test: if a person passes the test,
he is self-employed; if he does not, the
other status tests must be considered.
The main ones are set out below.
Note that many of those working in
construction and the 'knowledge-based
industries' (such as IT and management
consultancy) are likely to find the 'in
business on your own account' test harder
to meet. Generally speaking they find
work via an agency, have little or no
equipment or premises, work for a series
of engagers, often for longer than a month
at a time and almost invariably based at
the client's site. Although those involved in
this type of working may genuinely
consider themselves to be 'in business',
you are nevertheless advised that it is
essential in such cases to consider the
other status tests.
TolleyGuidance
Hiring staff
If a person has his own employees or subcontractors, he is very likely to be in
business on his own account. He will thus
be self-employed and not an employee of
his client. HMRC accept this, see
ESM0539.
Australian Mutual Provident Society v
Chaplin and Another (1978) 18 ALR 385
and accepted as an authority by the Privy
Council in Narich Pty Ltd v Pay-Roll Tax
Commissioner [1984] ICR 286
Personal service and substitution
If an individual does not have to do the job
personally, but can send a substitute, he
is not an employee. This is because
personal service is an essential ingredient
of employment.
Express and Echo Publications Ltd v
Tanton [1999] IRLR 367
However, simply putting a substitution
clause in the contract is not enough - the
right to send a replacement must be real.
This is discussed in more detail in the
Establishing employment status
guidance note.
If the right to send a substitute is limited so that, for example, the individual can
only send a substitute from a list of
approved people, and / or the engager
pays the substitute, this limited right is not
sufficient, on its own, to make the
individual self-employed. But it is
nevertheless a helpful indicator.
MacFarlane and Skivington v Glasgow
City Council [2000] EAT/1277
Employment Status: 03/10/12
Because substitution can determine
employment status, an assertion that a
person has such a right is likely to be
carefully scrutinised by HMRC. It has set
out what it will look for when examining
whether or not a person genuinely has a
right of substitution, see ESM0530 and
ESM0538.
Equipment
If an individual provides significant
equipment which is essential to carry out
the task, he is probably self-employed.
Ready Mixed Concrete (South East)
Ltd. v. Minister of Pension and National
Insurance [1968] 2 QB 497
Humberstone v Northern Timber Mills
[1949] 79 CLR
HMRC accept that if the individual owns or
leases equipment which is 'fundamental to
the service provided and sufficiently
important to affect the substance of the
contract', this is a 'very strong pointer' to
self-employment, see ESM0540.
However, if the individual only supplies
'small tools' then equipment is a neutral
factor, and is unlikely to help decide the
question one way or the other.
US v Silk [1946] 331 US, quoted with
approval in Ready Mixed Concrete
(South East) Ltd. v Minister of Pension
and National Insurance [1968] 2 QB 497
For a case where the provision of a
computer was a factor in determining
status, see Lime-It Ltd v Justin [2003]
STC (SCD) 15.
TolleyGuidance
Financial risk and opportunity to
profit
If an individual is paid on a fixed fee basis
rather than an hourly rate, so he can make
more money if he carries out his task
quickly, and stands to lose money if he
takes longer than expected, he is almost
certainly self-employed.
Global Plant Ltd v. Secretary of State
for Social Services [1972] 1 QB 139
HMRC accept that financial risk is a
'strong indication' of self-employment,
saying that
ESM0541
'the greater the financial risk the stronger
the pointer towards self-employment.
Individuals who risk their own money by,
for example, buying assets, bearing their
running costs, paying for overheads and
materials are likely to be self-employed.'
However, the reverse is not true - if an
individual is paid an hourly rate, it does
not necessarily mean he is an employee.
Many self-employed people, such as
solicitors and accountants, are paid on a
time basis.
If an individual is able to negotiate the
terms on which he works, he more likely to
be self-employed - most employed people
have limited or no freedom to negotiate
the terms of their contract, but accept or
reject the job which is on offer.
Being paid only after sending the client an
invoice means that the individual is taking
on more risk than an employee, and is an
indicator of self-employment. In Hall v
Lorimer (1993) 66 TC 349, The Special
Commissioner said that one of the
Employment Status: 03/10/12
reasons Mr Lorimer was self-employed
was because he:
'...bears his own financial risk which is
greater than that of one who is an
employee, accepting the risk of bad debts
and outstanding invoices and of no or an
insufficient number of engagements.'
Control
The level and type of control exercised by
the engager is a key factor in deciding
whether a person is employed or selfemployed.
The leading case law says that an
individual is an employee if he is subject
to the control of his engager 'in a sufficient
degree to make that other master'. It also
says that rights of control are divided into
control as to how, when, where and what
is done - and all these may need to be
considered.
Ready Mixed Concrete (South East)
Ltd. v Minister of Pension and National
Insurance [1968] 2 QB 497
Because control is a question of degree, it
is not a black and white test. You The
amount and type of control have to be
weighed up to see if it is sufficient to make
the individual self-employed.
The more freedom a person has as to
where and when he carries out his work,
and how he does it, the more likely he is
to pass this test. But in some cases the
location of the work, and the time at which
it must be carried out, are an intrinsic part
of the work, and the 'control as to where'
and 'control as to when' may then be
irrelevant.
For useful HMRC examples, see Example
1, Example 2, Example 3 and Example
4.
TolleyGuidance
HMRC's guidance on the control test
generally is at ESM0518-ESM0529.
Mutuality of obligation
Care is needed with this status test.
People sometimes seek to rely on the lack
of 'mutuality of obligation' to argue that
there is no employment. This may well
succeed in an employment status case,
but, as explained below, it is rarely
relevant for tax and NICs.
Mutuality of obligation means that the
individual agrees to carry out the work and
the engager agrees to pay for that work.
Mutual obligations are of course common
to both employment and self-employment
contracts and so this factor is rarely
determinative on its own. As the judge
said in a recent case involving the
employment status of a lap dancer
(Quashie v Stringfellows Restaurants
Limited [2012] UKEAT/0289/11/RN):
'a contract exists between me and an
emergency plumber. It contains mutual
obligations: the plumber must turn out
and fix the leak and I must pay her. She
is not my employee because control is
wanting. The finding of mutual obligations
to do with work does not go far enough
without control.'
There is no mutuality of obligation if the
individual does not have to turn up for
work, and / or the engager does not have
to offer the work if it is
available.Carmichael and Another v
National Power [1999] 4 AER 897
In employment law cases, where certain
rights only exist after a minimum period of
employment, mutuality is of relevance. In
particular, the employment tribunal may
Employment Status: 03/10/12
have to decide if the parties had
continuing mutual obligations during
periods when no work was carried out. For
a case examining mutuality in this context,
see North-west Probation Area v
Edwards UKEAT/0468/07/RN.
But once the individual has accepted
work, mutual obligations exist, see Prater
v Cornwall County Council [2006] 2 All
ER 1013.
Because tax and NICs status cases
invariably involve a period of time during
which work has been accepted, it is rare
for mutuality to make a difference to the
outcome.
Part and parcel
The 'part and parcel of the organisation'
test means that a person is more likely to
be an employee if he is integrated within
the organisation where he works - for
instance, because employees of the client
report to him, he conducts appraisals,
goes on team-building events and / or
attends employee functions.
This test was originally put forward by
Lord Denning in Bank voor Handel en
Scheepvaart NV v. Slatford and another
[1953] 1 QB 248 but was subsequently
criticised by McKenna J, who said it
'raises more questions than I know how to
answer.'
Despite this judicial stricture, the 'part and
parcel' test has been repeatedly used in
recent employment status and IR35
decisions, see for example Future Online
Ltd v Faulds [2004] STC (SCD) 237 and
Castle Construction (Chesterfield) Ltd
v Revenue and Customs Comrs [2009]
STC (SCD) 97. It is therefore advisable to
consider your client's position with regard
TolleyGuidance
to this test: do not simply rely on
McKenna's dictum.
Employment Status: 03/10/12
HMRC set out their position in relation to
Lorimer-type status situations at
ESM0551.
Lots of clients - the Lorimer case
Even if a person is not self-employed
under the status tests set out above,
following the case of Hall v Lorimer
(1993) 66 TC 349, he is likely to be selfemployed if he has a lot of clients for
whom he carries out work.
Mr Lorimer was a vision-mixer (the person
who decides which of a number of
different TV camera feeds actually
appears on the screen). He worked for
five production companies in his first year
and over 20 by his third year. The judge
described Mr Lorimer's client base as the
'most outstanding feature' of the case,
finding that he was 'independent of a
particular paymaster for the exploitation of
his talents'. Mr Lorimer was found to be
self-employed, despite the fact that, as
HMRC said:
'The studio company owns or procures
the supply of the equipment. The
production companies do not own such
equipment, still less does Mr Lorimer.
The equipment is an integral part of the
studio complex.'
The intention of the parties
The intention of the parties can be
described as a 'tiebreaker'. If all other
factors are evenly balanced, what the
parties intend the person's status to be will
normally settle the matter. This was most
clearly expressed by Lord Denning in
Massey v Crown Life Insurance Co [1978]
ICR 590:
'It seems to me on the authorities that,
when it is a situation which is in doubt or
which is ambiguous, so that it can be
brought under one relationship or the
other, it is open to the parties by
agreement to stipulate what the legal
situation between them shall be.'
However, labelling a role as 'selfemployed' is not enough: in the same
case, Lawton LJ said 'the parties cannot
change a status merely by putting a new
label on it.'
Starting out
In the judgment Lord Nolan quoted with
approval from the Special Commissioner's
judgment:
'It is said that Mr Lorimer provides no
equipment (i.e. he has no tools), he
provides no "work place" or "workshop"
where the contract is to be performed, he
provides no capital for the production, he
hires no staff for it. No, he does not. But
that is not his business.'
When a person starts out in business it is
often difficult to demonstrate that the
status tests are met - in particular, the
client base is likely to be very small. A
particular difficulty arises where redundant
employees are given a contract to supply
services to their former employer. This
may simply be disguised employment, and
so subject to PAYE and Class 1 NICs.
However, it may be the beginning of selfemployment. In Massey v Crown Life
Insurance Co [1978] ICR 590 (discussed
TolleyGuidance
above) Lawton LJ said that it was clearly
possible for a person who previously
worked as an employee to become selfemployed, albeit working for the same
engager:
"if in all the circumstances of the case,
including the terms of the agreement, it is
manifest that there was an intention to
change status, then in my judgment there
is no reason why the parties should not
be allowed to make the change."
HMRC have also provided helpful
guidance in ESM0553:
"Bear in mind though that someone
starting in business may in practice work
for the same engager under a series of
contracts because he or she is unable to
obtain contracts elsewhere. For example,
a professional worker may start in
business, set up an office and endeavour
to obtain engagements in a particular
field on a self-employed basis with a
variety of engagers. If he or she
continues to work in that vein but only
manages to obtain work for part of the
time through short-term contracts from
one engager, the fact that only one
engager is involved would not necessarily
mean those engagements are
employments."
Employment Status: 03/10/12
TolleyGuidance
Employment Status: 03/10/12
Employment status test
examples
Example 3
These examples of 'control over where'
relate to the Employment status tests
guidance note.
Worker B is also taken on to provide
accountancy services to the same
company in Example 2. The contract
specifies that the accountancy services
may be carried out at the office, or
worker's home, or elsewhere - at the
worker's choice. Worker B has an office in
her home. She has to cover the costs of
that office herself. This is a pointer
towards self-employment (if the engager
had covered the cost of working from
home this would be a pointer towards
employment).
Example 1
James is engaged to install a high level of
security on a Ministry of Defence
computer system. He can only do so by
accessing a military site between 10am
and 6pm. In this case the time and place
are fixed by the nature of his job, and do
not help decide the employment / selfemployment question.
This example is taken from ESM0523.
Example 4
This example is taken from ESM0523.
Example 2
This example is taken from ESM0523.
Worker A enters into a contract to provide
accountancy services to a company. The
contract with the company specifies that
the worker must work at the company's
offices. Worker A travels to the same
office every day where she carries out her
duties. This is a pointer towards
employment.
Worker C is taken on as a cleaner. The
contract requires Worker C to clean an
office block 5 evenings each week. The
nature of the work dictates where the work
has to be carried out. Therefore this factor
is not likely to have any significance in
determining status in this case.
TolleyGuidance
Establishing employment
status
This note explains how to work out
whether a person is employed or selfemployed. It considers the NIC deeming
rules, the contractual relationship between
the parties, the Employment Status
Indicator (ESI) and HMRC status
determinations together with how these
can be challenged. The reasons why
status is important is explained the
Employment status: why it matters
guidance note.
Remember that this note, and the other
notes on employment status, are only a
summary and you may need to take
further advice. For the position where
individuals are working through personal
service companies, see Personal service
companies overview. Please note that all
case references in this guidance note are
subscription sensitive.
The statute
For tax purposes the question of whether
a person is employed or self-employed is
established by the contract between the
individual and his engager, together with
the case law which has built up from
interpreting such contracts.
However, for National Insurance
Contributions (NICs), certain individuals
are deemed to be employed or self
employed. These deeming provisions
override the case law.
The most commonly encountered
categories are actors and entertainers,
cleaners, and people working for their
Employment Status: 03/10/12
spouses, while examiners are deemed to
be self-employed.
Social Security (Categorisation of
Earners) Regulations 1978 (SI
1978/1689)
Tolley's Practical NIC Service 2012-13
sets out the complete list of those affected
by the NIC deeming rules at Chapter 14.3,
with cross-references to more detailed
analysis of particular deemed
employments / self-employments.
However, note that with effect from 6 April
2012, the deeming rules for teachers and
lecturers have been discontinued, see
TIIN: Repeal of Categorisation
Regulations for lecturers, teachers,
instructors or those in a similar
capacity.
The contract
The NIC deeming rules apart, the starting
point when establishing employment
status is the agreement (contract)
between the individual and his engager.
Sometimes the contract will be written,
sometimes oral, and sometimes part oralpart written. It is naturally more difficult to
establish the terms of an oral contract,
and it is therefore advised that individuals
formalise their relationship with their
engagers in writing. Of course, the
contract will be effective for all purposes
and not just for tax and National
Insurance, so legal advice should be
taken.
Those seeking to advise on this area
should become fully conversant with the
status tests and the underlying case law.
These are summarised at Employment
TolleyGuidance
status tests. In particular, care is needed
when defining the extent of any control
over the individual by the engager,
whether there is a right of substitution, the
evidencing of any financial risk or
opportunity for profit and which party is to
supply equipment, tools and transport.
For more information on employment
contracts, see the Written statement of
particulars (terms and conditions)
guidance note, and other notes in that
sub-topic.
Is the written contract decisive?
The normal position under contract law is
that the written contract is determinative,
but the Supreme Court in Autoclenz v
Belcher [2011] UKSC 41 has recently
held that a different approach should be
taken for contracts between engagers and
individuals. This note first sets out the
position generally, and then considers the
position following the Supreme Court
case.
The position for most contracts
The normal position is that you can rely on
the written contract as an expression of
the relationship between the parties
unless:
o
o
o
the contract has been varied by
agreement, so as to change a term
of the contract
a term in the contract is a sham,
see Snook v London and West
Riding Investments Ltd [1967] 2
QB 786 and Street v Mountford
[1985] AC 809
the written contract does not
contain all the terms of the
Employment Status: 03/10/12
o
agreement, so that other
documents (such as an Employee
Handbook) actually form part of the
contractual terms, or it is a part-oral,
part-written contract
the contract contains a drafting or
linguistic mistake, in which case the
courts may accept that the
document should be read in the
way the parties intended, see
Investors Compensation Scheme
Ltd v West Bromwich Building
Society [1998] 1 All ER 98; Pink
Floyd Music Ltd v EMI Records
Ltd [2010] EWCA Civ 1429 and
Rainy Sky SA and others v
Kookmin Bank [2011] UKSC 50.
This principle may go wider,
allowing contracts to be interpreted
so as to give them 'business
efficacy'.
Contracts between engagers and
individuals
In Autoclenz v Belcher [2011] UKSC 41
the Supreme Court said that while the
principles set out above hold good for
'ordinary contracts' and, in particular,
commercial contracts, in contracts
between individuals and engagers the
courts have more latitude to disregard
terms included in the written contract. This
latitude derives from the parties' unequal
bargaining power (including the fact that
the written contract is almost invariably
provided by the engager).
The Supreme Court held that the true
contract is what the parties have actually
agreed, and this may not be reflected in
the written contract. The true contract is to
be discovered by considering 'all the
relevant evidence' including 'how the
parties conducted themselves in practice
and what their expectations of each other
were'. Moreover, the way the parties
behaved in practice 'may be so
TolleyGuidance
persuasive' that it is possible to draw an
inference 'that practice reflects the true
obligations of the parties.'
What are the consequences of
Autoclenz?
There is no doubt that Autoclenz marks a
significant change in the law. Contracts
which include terms inserted to make an
individual self-employed may be
disregarded if they do not reflect what was
actually agreed. This approach was
foreshadowed in Consistent Group Ltd v
Kalwak [2007] IRLR 560 when the judge
said:
'The concern to which tribunals must be
alive is that armies of lawyers will simply
place substitution clauses, or clauses
denying any obligation to accept or
provide work, in employment contracts,
as a matter of form, even where such
terms do not begin to reflect the real
relationship.'
However, it is important to stress that the
Supreme Court's message was that the
true agreement must be identified. This
means that if the parties genuinely agreed
that the individual would have a right of
substitution, it is irrelevant whether or not
a substitute was ever provided. The
Supreme Court confirmed that 'it does not
follow from the fact that a term is not
enforced that such a term is not part of the
agreement.'
As a practical matter, where both the
engager and the individual are content
with the arrangements, it will remain
difficult for HMRC to challenge the validity
of the written contract.
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In ESM0506-ESM0512 HMRC have set
out how they approach contracts in the
context of status investigations. That
guidance was written before the decision
in Autoclenz so should be approached
with caution.
The employment status indicator
(ESI)
The status tests are difficult and there are
many grey areas. HMRC have provided a
helpful online test called the Employment
status indicator (ESI), which individuals
can use to see if they are self-employed.
The ESI is anonymous. Participants are
allocated a ten digit ESI reference number
(look for it in the top left of the screen).
When all the ESI questions have been
completed, a copy of the 'Enquiry Details'
screen and the 'ESI Result screen' should
be printed out and / or saved
electronically. These screens will show the
ESI reference.
If the ESI shows the individual to be selfemployed, he can rely on this result if he
is later investigated by HMRC, provided
that:
o
o
o
the ESI test is completed honestly
(it is advisable to keep any
relevant documentation, such as
contracts, invoices and
correspondence, together with the
ESI result to show the basis for the
answers given to the questions)
the facts have not changed in the
meantime, and
copies of the Enquiry Details and
ESI Result screens have been
retained and can be produced for
HMRC
TolleyGuidance
Recategorisation by HMRC
The normal position is that the payment of
both PAYE and Class 1 employee NICs is
the obligation of the employer. However, if
HMRC find that an individual who has
been treated as self-employed is in their
view employed, their own guidance
requires the officer should first to consider
whether the individual should bear his own
PAYE and employee NICs.
ESM0119-ESM0120
There are two situations in which the
individual can be directed to pay the
PAYE which should have been deducted
from his earnings. The first is if the
employer 'took reasonable care' to comply
with the PAYE regulations, and the failure
to deduct was 'due to an error made in
good faith'. The second is if HMRC 'are of
the opinion that the employee has
received relevant payments knowing that
the employer wilfully failed to deduct the
amount of tax which should have been
deducted from those payments.'
Income Tax (Pay As You Earn
Regulations) 2003 SI 2003/2682, Regs
72, 81
It is also possible for HMRC to collect
employee's Class 1 NICs from the
employee, if the failure to collect was not
due to any negligence by the employer, or
if the individual knows that the engager
has 'wilfully failed' to collect the NICs.
There is no similar provision for employer
Class 1 contributions.
Social Security (Contributions)
Regulations 2001 SI 2001/1004, Reg 86;
NIM01022
Employment Status: 03/10/12
If the individual disputes the
recategorisation, and / or transfer of the
liability, he can appeal the decision.
Income Tax (Pay As You Earn
Regulations) 2003 SI 2003/2682, Regs
72B and 72C
Social Security Contributions (Transfer
of Functions) Act 1999, s 10
If HMRC decide not to seek to collect the
underpayments from the individual, they
normally ask the engager to pay tax and /
or NICs due by way of a contract
settlement; if that is not agreed, then by a
determination (see below).
COG915010
The amount due should normally be
reduced to take account of the income tax
and NICs already paid by the individual on
a self-employed basis. This is sometimes
known as the Demibourne principle
(following the case of Demibourne Ltd v
R & C Commrs [2005] STC (SCD) 667,
which triggered a change in the
legislation.
Income Tax (Pay As You Earn
Regulations) 2003 SI 2003/2682, Reg
72F
COG15245-15335
HMRC determination
If the engager does not agree with the
recategorisation, a formal determination
(for PAYE) and / or a formal decision (for
NICs) is issued.
Income Tax (Pay As You Earn
Regulations) 2003, SI 2003/2682, Regs
68, 80
TolleyGuidance
Social Security (Contributions and
Benefits) Act 2001, Sch 1 para 3
Social Security (Contributions)
Regulations 2001, SI 2001/1004, Sch 4
para 14(1)
For PAYE the normal four year time limit
applies, unless there has been fraud or
negligence.
TMA 1970, s 34
The time limit for NICs is six years from
the due date. Unlike PAYE, there is no link
to fiscal years.
Limitation Act 1980, s 37
For more on time limits for NICs see
Tolley's National Insurance
Contributions 2011-12 chapter 14.25
Effect of Limitation
Challenging re-categorisation
If HMRC seeks to recategorise, you
should of course first consider whether the
individuals are, in fact, self-employed.
To do this you will need to be familiar with
the case law in this area, see
Employment status tests. Note that, in
addition to the case law set out in that
note, some engagements are classified
differently for NICs purposes, see The
statute earlier in this guidance note.
It is possible to appeal the HMRC
determination / decision.
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