In recent years, work has become more flexible and increasingly remote. The rise of freelancers, contractors, and consultants has made some work relations more agile and adaptable. However, this new model of work has also raised questions about what is considered employment, self-employment, or disguised employment.
Under the IR35 legislation, this difference is crucial, as it determines if an individual should pay the appropriate taxes and National Insurance contributions.
Navigating IR35 can be challenging, and in this blog, we have already discussed what constitutes employment and what it means to be inside or outside IR35. In this article, we will discuss disguised employment and how it can lead to shifts in taxing responsibilities.
What is disguised employment?
Disguised employment refers to a situation where an individual works as a contractor or freelancer through an intermediary – such as a limited company or a personal services company – but performs work that would be considered employment if they were engaged directly by the client.
In this case, the contractor’s relationship with the client resembles that of an employee in terms of their working arrangements, duties, and level of control. However, due to the form of contract, these individuals are not seen as employees by the client company.
If a contractor is deemed to be working in disguised employment under IR35, the responsibility for determining their tax status shifts from the intermediary to the client or the end-user. As a result, the client must assess whether the contractor should be treated as an employee for tax purposes and if they must deduct the relevant income tax and National Insurance contributions from the contractor’s payments.
What is the difference between disguised employment and actual employment?
Disguised employment and regular employment differ primarily in how the work and the contractual arrangements between the worker and the employer are structured.
It’s essential for both workers and clients to understand the differences between the two and properly assess the working arrangements to ensure compliance with relevant tax and employment laws. Misclassifying workers as contractors when they should be considered employees can lead to legal and financial consequences.
Here are the key differences between the two:
In disguised employment, the worker typically operates through an intermediary contracted to provide services to the end client. The worker is the owner or director of the intermediary and is responsible for managing the company’s affairs.
If there is a regular employment relationship, the worker is directly employed by the client or employer. They have a contract of employment which outlines the terms and conditions of this relationship.
Control and direction
If a worker in a disguised employment arrangement is being treated like an employee, they might have little control over how and when they perform their work. The end client might dictate their working hours, location, and specific tasks, resembling the level of control seen in traditional employment relationships.
In a regular employment relationship, the employer typically exercises a higher level of control over the employee’s work.
Employment rights and benefits
Workers operating through intermediaries might not receive the same employment rights and benefits as regular employees. They may not be entitled to sick pay, holiday pay, pensions, or other benefits offered to employees. Employees usually have various employment rights and benefits provided by their employer.
Tax and National Insurance contributions
If a worker is deemed to be in disguised employment under IR35, they will need to pay the appropriate taxes and National Insurance contributions similar to regular employees. The responsibility for determining this status and ensuring proper tax compliance may fall on the end client.
In a standard employment arrangement, the employer deducts income tax and National Insurance contributions from the employee’s salary and pays these to the relevant authorities.
How do you know you are a disguised employee?
Determining whether you are a disguised employee or genuinely self-employed can be a complex process, and there is no single definitive test. The assessment typically involves considering several factors related to your working relationship with the client or end-user.
It is crucial to review the specifics of your working arrangement carefully, including your contract, day-to-day working practices, and the level of control and independence you have. If you are uncertain about your employment status, you may seek professional advice from an employment lawyer or tax advisor or consult HM Revenue & Customs (HMRC) in the UK, as they can provide guidance on the IR35 rules and help you understand your tax and employment obligations.
Here are some key indicators that may suggest disguised employment:
1. Control and supervision
If the client exercises a significant amount of control and supervision over how you perform your work, including dictating your working hours, location, and specific tasks, it might indicate an employment-like relationship.
2. Mutuality of obligations
If the client is obliged to provide you with work, and you, in turn, are obliged to accept and complete the work, it can resemble a typical employer-employee relationship.
3. Personal service
If the client insists that only you can perform the work and you cannot send a substitute or delegate tasks to someone else, it might indicate a more employment-like arrangement.
If you are fully integrated into the client’s business, working closely with their employees and using their tools, equipment, and facilities, it might suggest an employment relationship.
5. Financial risk
If you bear no financial risk for the success or failure of the project and are paid a regular salary or fixed fee, it may resemble a traditional employment arrangement.
6. Right to terminate
If the client can terminate the contract without cause and without notice, it may indicate a more employment-like relationship.
7. Benefits and perks
If you receive benefits and perks similar to those provided to regular employees, such as access to company-provided health insurance or pension schemes, it might suggest an employment relationship.
8. Duration and exclusivity
If you have an ongoing, long-term relationship with the client and exclusively work for them, it might resemble a typical employment arrangement.
What are the consequences of disguised employment?
If a contractor is found to be in disguised employment, there might be consequences for both the worker and the client company.
Since navigating tax laws and regulations can be difficult, it is recommended that companies seek professional advice when assessing contractors’ employment status and ensuring compliance with tax regulations.
Implementing proper contractual arrangements and working practices that reflect a genuine self-employed status can reduce the risk of the following consequences:
Tax and National Insurance liability
If a contractor is deemed a disguised employee, they will be subject to similar tax and National Insurance (NI) contributions as regular employees. The client is responsible for deducting income tax and NI contributions from the contractor’s payments and remitting them to HM Revenue & Customs (HMRC). Additionally, the contractor may need to pay any outstanding tax and NI contributions for previous periods if they were not correctly accounted for.
Penalties and interest
If it is discovered that IR35 rules were not applied correctly, both the contractor and the client may be liable for penalties and interest on unpaid taxes and NI contributions. The exact amount of penalties and interest depends on the severity of non-compliance and the specific circumstances of the case.
Backdated tax assessments
HMRC can perform tax investigations and assessments going back several years if they suspect that IR35 rules were not correctly applied. This could result in the contractor owing additional tax and NI contributions for past contracts.
Loss of tax relief and expenses
If a contractor is found to be in disguised employment, they may lose some of the tax reliefs and expenses that are typically available to self-employed individuals. This can lead to a higher tax liability for the contractor.
In some cases, the client might decide to change the working arrangement to bring the contractor within the scope of regular employment. This could involve renegotiating the terms of the contract and offering employee benefits.
Impact on future contracts
Being found in disguised employment can affect a contractor’s reputation and make it more challenging to secure future contracts, as clients may be hesitant to engage with contractors with an IR35 compliance issue.
Navigating the realm of disguised employment and understanding the implications of IR35 is an important task for both contractors and businesses. With work arrangements becoming more flexible, the line between genuine self-employment and disguised employment becomes increasingly blurred.
For contractors, showcasing genuine self-employment status requires a proactive approach to structuring contracts, demonstrating autonomy, embracing multiple clients, and upholding financial independence. Engaging with expert advice and adopting best practices can bolster compliance and mitigate any potential risks associated with disguised employment.
Businesses engaging with contractors must also exercise prudence and due diligence in their working relationships. Accurate and fair IR35 assessments are essential to avoid potential tax liabilities, legal ramifications, and damage to their reputation as ethical employers.