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Self employed contractors do look like a cost effective staffing solution. But, self employed contractors can create tax problems. The tax exposure often comes to light long after the contractor has left with either no trace and/or with few assets worth pursuing. This causes unrecoverable costs for the business which may have been avoidable.

Based on past experience, we highlight the likely exposure to self employed contractor tax issues and how to guard against risks.

We work with both service providers and end users.

How do you know if the contractor is self employed?

The law is currently a mess. This is why self employed contractors can create tax problems.

There are three categories of staff in this country and the changing working pattern is blurring the distinction.

1. Employees

On the one hand we have employees – not a problem in terms of exposure for the employer as PAYE applies.

2. Genuine self employed contractors

At the other extreme we have the genuine self employed – not a problem for the employer.  This is because under current tax rules the employer has no exposure as the self employed contractor is responsible for his or her tax.

3. Problem cases – the middle and a growing number

It is in the middle where we find the problems.

  • The middle comprises workers – entitled to certain statutory rights such as holiday pay but not subject to PAYE. Many contractors in the gig economy are workers.  There has been a spate of cases where workers successfully claimed employment rights. Will HMRC now pursue PAYE assessments on the employers – remains to be seen.

The middle also includes contractors operating via personal service companies. If HMRC cannot assess them to tax under IR35 the risk is they assess the employer under the disguised remuneration rules.

Self employed contractor tax and IR35 reform

HMRC does not wish to abolish IR35. But, HMRC wants to extend the scope to bring more contractors within PAYE. Moves are ahead in the form of the new rules for public bodies explained below. It is likely that the concept will be rolled out to all end users in due course.

Such a move will bring an end to the self employed contractor tax issues for a very large number of businesses.

The reforms will increase the payroll costs as employer’s and employees’ class 1 national insurance will be due. HMRC is not concerned with who will pick up the additional costs.

That will be a matter for negotiation.

Implications upon a contractor being re-assessed as employed

The re-assessment of a contractor’s status for tax purposes usually comes to light following a PAYE audit or random inquiry. HMRC have sector focuses such as the IT and tech sector.  Personnel involved in the TV and media industries are a current HMRC focus sector.

Another avenue for re-assessment arises is if an Employment Tribunal decides a worker or contractor was employed. The status for tax purposes and status for employment law purposes are distinct tests. However, HMRC will no doubt agree with the Employment Tribunal’s judgement.

HMRC does not have to give credit for any income tax and National Insurance paid by the worker under self-assessment when calculating the employer’s liability arising when the status was re-assessed by the Employment Tribunal.

Self employed contractor tax penalties

Even if the business can set off income tax/national insurance paid by the worker against its own tax liability, the business still faces penalties for failing to operate PAYE or make national insurance contributions.

HMRC calculates penalties for lodging inaccurate PAYE/national insurance returns as a percentage of the total amounts that should have been paid for up to six years. HMRC does not take account of income tax or national insurance paid by the worker under self assessment during this six year period. The penalty percentage will depend upon the level of intent and concealment. We can argue a reduced penalty percentage with the right evidence.

HMRC IR35 assessments

HMRC does operate on online service that can confirm whether IR35 will apply. Providing the information submitted is correct, HMRC will stand by the test result.

However, there are problems. The test, being designed by HMRC, will fall on the side of caution, i.e. the contractor is caught by IR35. There is no substitute for professional advice.

In addition to this, if the result cannot be backed up with a fully documented contract with bespoke terms, a HMRC investigation may nevertheless determine an exposure to PAYE.

Self employed contractors in the public sector

IR35 has been effectively extended. The extension passes the responsibility for operating PAYE from the contractor under IR35 to the public body. HMRC thinking is, it is easier to chase a public body than it is a personal service company or self employed individual.

Operation of the rules for public sector end users

If the end-user is a public body, then there are compliance steps to be taken. These are as follows:

  1. The service provider must provide the public body with all information necessary to determine if the off-payroll rules apply; and
  2. If the off-payroll rules do apply, then the public body must account for PAYE and NICs prior to making payment to the service provider.

This opens up a new stream of negotiations. As the public body is responsible for determining if the off-payroll rules apply, a common requirement is for the service provider to indemnify the public body for all taxes due (income tax, national insurance, penalties/interest) if the public body gets the assessment wrong and an investigation commences.

Self employed contractors will create problems when there is a lack of documentation

Despite the risk of significant tax liabilities when engaging contractors we do see many cases where there is no written documentation. This causes much of the problems that self employed contractor tax creates.  Whilst written documentation will not finally determine the status of a problem, an agreement setting out what you thought the position was will assist.

Addressing intellectual property use and creation

The usual rule in an employment relationship is that the employer owns what the employee creates. However, this is not always the case in consultancy/contractor relationships.

Issues can be particularly acute for contractors involved in software related engagements where copyright and patents are involved.

We do offer an IP audit service whereby we can assess who owns what intellectual property.

We find most problems result from a lack of bespoke terms addressing intellectual property use and creation. If there is no contract, employers cannot stop contractors walking off with intellectual property such as:

  • Customers lists;
  • Employee contacts;
  • Software coding;
  • Inventions or works created during the course of the engagement;
  • Know-how; or
  • Source code.

The risk is that you may find an intellectual property dispute emerges when the relationship ends.

For employers and end-users we draft and review contracts for self employed staff. Most clients want to address the tax position. We have the expertise to find solutions.