Dear Contractor Doctor
I am facing redundancy and being put on gardening leave for the duration of my six-month notice period.
But I have been offered the opportunity by a former colleague who went freelance to work on a short-term contract with her, and she is suggesting I can tax efficiently channel my earnings from this work by incorporating my own company or joining an umbrella company.
Can I start a contract when I am on gardening leave?
Contractor Doctor says:
Employees on gardening leave are usually put ‘on hold’ for their employer’s benefit, and not their own – it is not designed to be a lengthy, expenses-paid holiday for the worker.
The objective is to ensure that the employee does not start work immediately with a competitor, especially when they will have fresh information and enduring client relationships that may damage their former employer.
Contracting via a limited company or umbrella company means that the worker is employed by another employer – the limited company or umbrella – which may breach the worker’s employment contract.
However, if the work required by the contract would cause no commercial damage to the original employer, the employer may be prepared to negotiate, because it may save it a substantial amount of money that way and still bear no risk from its ex-employee’s departure.
What does the contract say?
The options available to a worker on gardening leave who is considering becoming a contractor very much depend on what is in the contract, or in the gardening leave agreement, if there is one. It is common for the contract to expressly forbid the worker from alternative employment during the gardening leave period, in exchange for full pay and other benefits.
If that’s the case, then the contractor cannot go contracting via their own limited company or an umbrella company because they would be employed again by a third party, even if that third party might be their own business. This may place them in breach of their existing employment contract.
The options available to a worker on gardening leave who is considering becoming a contractor very much depend on what is in the contract
Furthermore, gardening leave agreements usually require the worker to be on hand to deal with any issues or questions arising from their former role during the leave period. If the worker is out on a contract, they may not be in a position to respond to questions in a timely fashion and again be in breach of their leave agreement or employment contract.
If the contract is non-competitive, try negotiating
Workers able to secure work which in no way competes with what they did for their former employer may be able to negotiate an early exit. This may be especially true if the contract offers work in a different geographical or sectoral market.
After all, the prospect of the employer achieving the same result of their ex-worker being unable to pass on any trade secrets or poach any clients but without having to pay for it is highly attractive.
The employer may still try to place restrictions on their former employee-turned-contractor, but this is a matter for negotiation. New contractors in this position should ensure that the terms of any new agreement do not excessively favour their former employee.
The risks of taking a gamble
Of course, one option is for the worker to take a gamble, start work on a contract and hope that their employer never finds out. Although it is possible that the employer will never find out, this may be a high risk option, particularly if the contract is with an organisation that might be a competitor, or a former customer of the employer.
The employer’s sanctions depend on what is in the contract. If the employer finds out that their employee on gardening leave is ‘moonlighting’ on a contract, they could terminate the contract immediately. This might be what the worker wanted all long, but not if it comes with the loss of all earnings, benefits and other incentives, such as share options or bonuses.
It is also possible that the employer may take legal action by taking the worker to court and demanding damages for perceived losses that resulted from the worker, for example, starting a contract with a competitor organisation.
Incorporating for the purpose of a single contract
In the event that an employee on gardening leave secures the permission of their employer to work on a contract, the contractor should consider their trading option carefully.
If the gardening leave period is short, and it is likely that the contractor will only work on a single contract before they seek another permanent role, then an umbrella company may be the best option.
That’s because a contractor incorporating a company for the purpose of a single contract cannot claim travel and subsistence, yet will still have the expense of running a company.
HMRC’s rules say that for tax purposes, the location of that single contract is the contractor’s place of work, and therefore travel expenses to that place of work cannot be claimed.
The overarching employment contract that a compliant umbrella company provides enables contractors to claim expenses, and the resulting income tax and National Insurance Contribution (NIC) relief.
If the leave period is longer and the worker is likely to work on more than one contract, or if the worker makes a career choice to become a full-time contractor over the long-term, then a limited company may become an attractive option.