The Office of Tax Simplification (OTS) has a new project, its Employment Status Review. The project’s terms of reference state that the objective is: “To examine the dividing line between employment and self-employment and whether it is drawn in the right place and in the right way.”
The review is specifically not designed to tackle the issue of IR35, but if the outcome of the review is a change in how employment status is determined, then it will impact on IR35 and contractors. Employment status is fraught with uncertainties: just defining the problem for the Employment Status Review will be the first challenge:
- Are employment and self-employment the only two options, or is there a third way?
- Employment and self-employment are two extremes of a continuum, with a huge grey area in-between
- An essential ingredient for a working tax system is certainty, for employers, employees, the self-employed and those enforcing the rules
- Currently one set of employment status principles is delivering different outcomes for determining employment rights and taxation
- Determining employment status for tax reasons will always be necessary whilst there is a disparity between the tax paid by the employed and the self-employed
- The best solution would arise from a ‘greenfield’ approach, but the reality is that it will include elements of the existing situation. .
The OTS has started its information gathering process for the Employment Status Review with a series of questions to employment status stakeholders and meetings with interested parties.
Employed, self-employed, worker or other?
From the outset, the issue is to consider whether employment and self-employment is an ‘either, or’ state of being, or whether there is an in-between state of say freelancer or contractor?
There is also a worker status which appears in employment law, mainly driven by European Union directives. Case law suggests that you can be a worker with attributes of both employment and self-employment. So, this could add a further level of complexity.
Is being a freelancer or contractor another mode of working, a third way? Or are there simply two states, either employed or self-employed?
A huge grey area in the middle adds complexity
Let’s consider only two states of being: employment and self-employment. We know from fifteen years of grappling with IR35 that you have the two extremes of being definitely employed and definitively self-employed with a huge grey area in-between.
In practical terms, there is a continuum from employment to self-employment. There are some employees who are not role based. They work on projects and may appear to operate autonomously but their contract says they are employed.
Equally, there are contractors who may have the same client and work on the same site for years, because that’s how long the project lasts. Yet their contract says they are self-employed (or to be more specific, are employed by their personal service company, and not employed by the client).
Even without using employment status case law that has taken decades to develop, it is clear that the two scenarios include indicators of both employment and self-employment. But the contractor looks employed and the employee looks like a contractor.
Certainty and simplicity is needed, but it is currently lacking
This grey area is what creates one of the major challenges for the Employment Status Review when attempting a simple solution. Trying to draw a line between the two statuses is exceptionally complex making it very difficult to reach a state of certainty.
In fact, there is a strong argument that the existing method of determining employment status by using employment status case law is unsuited to form the basis of the tax system. Because to work, a tax system needs certainty. Those that enforce employment and tax law also need certainty, such as the employment tribunals, HMRC status inspectors and Tax Tribunals.
The problem is that the best rules we have for determining employment status are those based on case law that has evolved over decades. These rules have developed by being tested by the courts by the best legal minds we have – the judiciary. But that does not make them any less complex, or any more suitable to use for tax purposes because they don’t meet the certainty criteria required.
One set of rules is delivering inconsistent outcomes
Employment status is determined for one of two reasons: either to find out if a worker should have employment rights or whether they should be taxed like an employee or taxed as a self-employed worker.
The employment tribunal service does seem to work as workers who are clearly employees but hired on a self-employed basis are being granted employment rights. On the flip side, there are many contractors paying tax like employees, because they have to implement IR35, but who are being denied employment rights. Why do we have a system of evaluating status that rewards one but not the other?
The inherent problem is that the rules used to determine employment status for the purposes of granting employment rights are being applied to employment status for the purposes of taxation. And the rules don’t work very well in translation.
Why is employment status so important to classify?
Workers who have no intention of being self-employed and are seeking employment should be employed and should receive employment rights. Establishing employment status in this context is clearly necessary.
But do we need to establish employment status for tax purposes? HMRC certainly wants to, because of the disparity between how much tax the employed and self-employed pay. Misclassifying employees as being self-employed reduces the tax collected for the Treasury. The self-employed, when using a limited company, can pay as much as 25% less tax than an employee.
Using self-employed workers is more attractive commercially for employers because they avoid the ‘jobs tax’ of employer’s National Insurance Contributions (NICs) which they have to pay for employees.
However, if there was no disparity between the amount of tax paid by employees and the self-employed, would we be having this debate at all? There would be no reason for the taxman to determine whether a worker was employed or self-employed because it would be irrelevant.
Greenfield or brownfield solution
But there is a big disparity between the tax paid by the employed and the self-employed. Should this problem be considered in the light of this disparity, or is the best option to start from first principles, taking an empirical or greenfield approach?
The reality is that, although it would yield a better result, the greenfield approach to the Employment Status Review is not practical. Any definition of the problem and ultimate solution will need to adopt a brownfield approach that considers where we are and what has gone before.