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How to determine employment status

Last updated: 31 March 2022

How to determine employment status

The question of employed or self-employed is fundamental to how IR35 is applied. If you can prove that you are self employed you can work through a limited company and benefit from the significant tax savings that are available to directors of limited companies. You cannot simply choose whether to be an employee or self employed – it will depend on the type of contract you have and the terms and conditions in it.

It is not overly straightforward to determine employment status. Tax law and social security legislation does not define ‘employment’ and ‘self-employment’, but HMRC introduced IR56 to clarify the issue and reduce misinterpretation and determine a contractor’s exact IR35 status. click here to see HMRC’s own definition of self-employment.

Your contract and what you actually do (and not just what is written on paper) will need to be considered. While it is strongly recommended that contractors and freelancers speak to an accountant or take other specialist advice the following information should help clarify the situation.


How do you prove self employment?

Broadly speaking if you are self-employed you are in business on your own account and bear the responsibility for the success or failure of that business.

You should make sure you are engaged under a ‘contract for services’ (although on its own this would not be enough to satisfy any tax official!). You also need to show that the relationship between yourself and your client is one of self-employment. To show self-employment, for example, perhaps you do not do the work directly yourself and have the right to send someone else, or you can do the work in your own time and/or wherever you choose and you can decide how you do the work as long as it is completed in accordance with the contract.

The above criteria are some of the main pointers towards genuine self-employment. Other factors can also indicate self-employment, but not on their own. For example maybe work performed is specified in the contract and the client has no right to direct you to do other work. Perhaps you take financial risks, have several other work contacts at the same time, or with different clients in succession. Perhaps you have an office at home, your own business cards and stationery and you have to actively seek contracts with clients. And you do not receive any employee type benefits such as sick pay, holiday pay or pension contributions. Other minor indicators include signing the visitor’s book and having to obtain a visitor pass. Or being a guest or always giving advice as an independent consultant.


Why not simply operate as a self-employed sole trader?

You should remember that if you do operate on a sole trader self-employed basis you will have to find clients directly and not through an agency. Agencies won’t employ you because if your tax status is challenged they become liable for any additional tax and NIC due. Furthermore the Income Tax (Earnings and Pensions) Act 2003 Section 44 effectively prevents individuals from being self-employed where an agency is involved as it obliges the agency to treat the clients as if they are employees i.e. deduct PAYE.

Even if you are happy finding your own clients – and want to be self-employed and outside the IR35 – you must still meet the IR56 criteria. Again, it is possible to be outside IR35 for one job and inside it for the next, depending on the terms you are engaged under. If you cannot prove you are self employed for a particular job you will be caught by IR35. Even so you will still be able to operate as a Limited company (though obviously for that assignment you will be subject to PAYE and NIC). Each time you have to be able to prove you are genuinely self-employed. By signing the form that says you are outside IR35 it is your responsibility to ensure your relationship with future clients also meets the self-employment test.


Being employed through an umbrella company

If you work through an umbrella service you are essentially a PAYE employee of the umbrella. Your client or agent enters a contract with the umbrella for your services and you enter a contract with the umbrella. You send in timesheets and expense details and get paid after tax and NIC are deducted. The essential thing to remember here is that using an umbrella company will not protect you from IR35. While it is true that IR35 does not apply to the umbrella company itself – because you, the contractor are an employee and get paid PAYE – IR35 status is determined by the contractors’ working relationship with the agency and the client and the contracts involved.


What does the law say?

Because of the Proceeds of Crime Act 2002, accountants and other advisors have to have systems in place to prevent money laundering. Money laundering encompasses criminal acts – and tax evasion qualifies as a criminal act – so if your accountant thinks you are avoiding tax by being outside IR35 when you should be inside it, or declaring yourself self-employed when you are in fact employed he or she must report you or face criminal prosecution. Any decent accountant will make sure contractors understand and follow IR56 and IR35, but they probably won’t read every contract you enter into. Each has to be judged on its own merits, and the only way to be certain you are genuinely self-employed for each job.

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