All construction businesses must fully understand the tax status of their contractors, says Shimon Shaw.
Anyone who operates a substantial construction business will almost certainly have a number of specialists working for them.
In theory, one of the simplest questions someone running such a business should be: "Are you their employer or are they self-employed?" However, it is only too easy for the lines between employment and self-employment to become blurred – this can then create real problems for both the employer and the people they engage.
Legal Implications
There will be employment law implications of finding one way or the other, which will affect the rights and responsibilities of both parties to each other, including the statutory rights of employees, for example in the context of unfair dismissal.
For income tax, the question of whether someone is an employee is particularly relevant to whether or not the employer should operate PAYE. For workers in the construction industry, if PAYE is not operated, they will fall within the construction industry scheme. Minimum wage requirements will also need to be considered.
Employment status also determines an individual’s liability to pay National Insurance contributions (NICs). The general rule is that a person engaged as an employee or office holder will be liable for Class 1 NICs. A person engaged on a self-employed basis will be liable for Class 2 and, normally, Class 4 NICs. There may be tax implications for both the engager and the worker.
The self-employed worker may also be required to register and charge VAT to their employer. They will need to produce VAT invoices and account to HM Revenue and Customs (HMRC) for their output VAT. In these circumstances the self-employed person should consider using the flat rate scheme for VAT.
Any finding will therefore have financial and tax compliance implications for the contractor and those working for them. It is important that employers in any industry determine whether they want to have employees or self-employed people working for them, and consider the terms of their contracts accordingly.
Employment Status
If HMRC feels that there is some doubt over a worker’s employment status, the officer appointed to consider the case will carry out a status enquiry. This is a fact-finding exercise which may include field visits, interviews (possibly with both the engager and the worker), and examination of documents and contracts. They will then issue a written opinion letter which is informal but binding on HMRC unless disputed.
Understanding what HMRC is looking for in advance is critical to ensuring you implement the right contract. It is always more cost-effective to procure advice up front, before drafting standard terms, than to have to defend and address a detailed revenue status enquiry. The table sets out some of the key areas that may be considered, and what HMRC will be looking for.
In the construction industry in particular there are certain standard forms of contract used to engage sub-contractors. The contractor or employer will ultimately need to balance their tax and compliance considerations with the need to have commercially acceptable terms. For example, it will be hard to justify an all singing and dancing Joint Contracts Tribunal (JCT) contract when employing your carpenter for a two-day job at £10-an-hour.
Finally, it always needs to be borne in mind that the modern tax system looks more at substance than form. You may have the most watertight contracts to demonstrate employment or self-employment, but if the reality is different, then the tax will follow what happens in practice. It is important to remember that no single feature will ever be conclusive - HMRC will always be looking to build a pattern of behaviour.
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What HMRC Will Ask |
The Contract Should Contain: |
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Does the engager have ultimate right of control over what tasks have to be done, where the services have to be performed, when they have to be performed and how they have to be performed? |
Freedom for the worker to choose the manner in which their duties are performed within parameters that ensure the correct job is done. (The degree of specification will indicate to HMRC whether this is employment or not.) |
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Does the worker have the right to provide a substitute or engage helpers? |
It is indicative of self-employment if the worker may subcontract their duties. |
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Who has to provide the equipment and/or materials? |
It is indicative of self-employment that the workers provide their own equipment or materials. |
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Does the worker have a real risk of financial loss? |
An employee does not generally share the risks and rewards of failure or success unless, for example, there is a performance related bonus. |
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Does the worker have the opportunity to profit from sound management by reducing overheads and organising work effectively? |
If one is getting paid per job (as opposed to a salary) cutting overheads would lead to a higher take-home pay. |
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How is the worker paid – daily, monthly at the end of the job? Are they paid by hour or by job? |
Payment by the job implies self-employment. |
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Are there ‘employee type’ benefits, such as sick pay, pensions or holiday pay? |
Benefits tend to be part of an employment relationship. |
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Does the worker work exclusively for the engager? |
This is not conclusive, for it is quite normal for a subcontractor to work exclusively for the duration of a job. When they only ever work for one person, this indicates employment. |
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Is the worker part and parcel of the engager’s business or organisation. |
The more they are involved, the more likely they are to be employees. |
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The intention of the engager and worker as regards employment status. |
This will be clear from correspondence and the contract. |
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
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