Contents
Background
How Worried Should You Be?
Tax On Hiring Self Employed Workers
How HMRC Decide On The Employment Status
Summary
Background
Small businesses, especially start-ups prefer to hire workers who bill them through their own business, instead of as permanent employees. This is mainly because they can save a lot when it comes to taxes and other employment costs, for example by not having to pay employers national insurance contributions or provide holiday/sick pay or deal with autoenrollment on a pension scheme. There are also the added benefits of having more flexibility in their working conditions and contract.
While you’re here why not check out our Ultimate guide to tax deductions available for limited companies, it’s packed full of tax saving ideas that many accountants don’t even know about.
So you’re probably reading this article because you’re worried about the risks involved in hiring self-employed workers because many other articles out there explain about how HMRC can come down on you like a ton of bricks if they think that you’re doing it just to avoid paying your fair share of tax.
There are certainly many chartered accountants advising small businesses based on their most conservative approach and this can leave entrepreneurs worried and anxious about where they stand. In fact we recently had someone call us from the other side of the country even though our accounting firm is based in Northampton, because they were so worried about this. It can be so hard to find an answer to this, that many people can’t even get one from their local accountants, so they have to reach out to us instead.
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Can you hire self employed people?
The answer is yes and the correct way to do it is to have a solid contract in place which would typically be different to your standard employment contract. I’ll cover some of the criteria to consider later in the article. The self-employed worker can then invoice you for the work based on the conditions you’ve agreed.
One other thing to consider is that even if they are self-employed, do you work in an industry where you need to put them through a payroll system and deduct National Insurance? This is not an obvious consideration but does apply to certain businesses like commercial cleaners and many business owners actually fail to apply it properly. If you have a trades related business then you should be aware that the Construction Industry Scheme criteria might apply and you will need to deduct tax from your subcontractors before you pay them and hand it over to HMRC under the CIS.
It is also worth considering the type of insurance you need and the risk assessment required as there are many instances where you would have a certain degree of liability for the work they do and also for their safety and welfare.
There is in fact no limit to the amount you can pay someone before you have to put them on your payroll in the UK, although as discussed later in the article the risk does increase the more they earn. Self-employed workers typically don’t have a tax code either, but there are some exceptions in the case of Off-payroll working where they need to be added to payroll returns for legislative reasons.
The current rules
Typically it is an employers responsibility to collect the right amounts for tax purposes under the PAYE scheme rules and this means that in the event a self-employed person who is deemed to be a disguised employee had underpaid tax, the deemed employer would be responsible for covering it. This creates an interesting contrast between businesses hiring sole-traders and hiring people who were working through their own personal service company (PSC).
It has always been the preference of small businesses to hire people who would work through their own limited company as it would protect the hirer in the event of disguised employment status tax enquires. Ultimately the self employed persons own personal service company is their employer and the responsibility for underpaid tax can’t shift away from that, unless the IR35 exemption for small businesses doesn’t apply.
IR 35
HMRC were so frustrated with the tax they’ve lost historically to self employed people that they created a piece of legislation called IR35, which allowed them to determine whether on not someone was a disguised employee and then apply the lost employee taxes and penalties to that person or the company they worked for. Even in cases where the self-employed person was working through their own limited company, HMRC could transfer the responsibility for the lost tax to the self employed worker and negate the protection the limited company usually provides.
There has been a lot of discussion in the news over the last few years about the changes to the IR35 rules which mean that the business hiring the self employed worker is responsible for the lost tax and penalties and not the self-employed worker themselves. If you’re a small business reading this then you should be relieved that there was actually an exemption for small businesses with a turnover of less than £10M, balance sheet worth less than £5.1M or with less than 50 employees (2 out of the 3) in the legislation.
How worried should you be?
While it depends on the exact circumstances, for most honest people running small businesses the answer is probably not as much as they think. Firstly you have to consider if there is an actual risk from a tax perspective, ultimately HMRC make their money by launching enquiries in order to reclaim tax and potentially add penalties and interest on top of that so they will not want to waste their time if there is no financial gain.
A good question to ask your accountant is “If this freelancer was an employee, would there actually be any tax due on the amount I’m paying them?” If you’re actually not paying them enough to trigger any tax bills, perhaps because everything they earn is covered by their personal allowance or below the primary or secondary NIC thresholds, then the chances are that there is very little risk to your business. A qualified chartered accountant should be able to work this out for you very quickly, so it’s definitely worth having the conversation to put your mind at ease.
Typically in the past HMRC has lost 4 out of 5 cases in tax tribunals where they challenge someone’s employment status, as the criteria which I’ll outline further down in this article are incredibly subjective and it can be very difficult for them to prove in court. There is an argument in the accounting community that because of HMRC’s abysmal record in enforcing disguised employment related, they have alternated to creating a fearful and intimidating environment for small businesses hiring self-employed workers to deter it that way instead.
HMRC have developed a useful tool in checking the employment status of a worker, however when using it you should consider that it is likely to be biased towards HMRC’s position and that nothing when it comes to employment status is black and white.
Tax on hiring self employed workers
Do Self-employed people still pay income tax?
This question really depends on whether or not the self-employed person is working as a contractor through their own limited company or if they are doing it as a sole trader. Sole traders pay tax at 20% and sometimes at 40% and even 45% depending on their self-employed income. Depending on if they are in the basic, higher or additional rates respectively, this is also true of employees in any tax year.
What national insurance contributions do self-employed people pay?
Typically people working as a sole-trader will pay class 2 national insurance at £2.75 per week and also class 4 national insurance contributions at 9% (2022-23 tax year). Just like with income tax there are still allowances and thresholds available, which mean that they don’t have to pay tax on all of their income.
What taxes do limited companies pay?
Self-employed contractors working through their own limited companies have different tax obligations. Typically they will receive a salary from their company which in most cases will be tax free, although there might be a small amount of secondary national insurance contributions to pay. Overall limited company owners benefit from tax savings compared to their unincorporated counterparts as the corporation tax rate they pay is around 19%, although this can be higher depending on their profits. Dividend tax for comparison at the basic rate is also around 7% (8.75% official) so overall 26% can be paid instead of approximately 30% that is due for other self-employed staff.
Regardless of how the worker status is achieved, self-employed people must file an annual self-assessment tax return if they have some of the taxes mentioned above to declare as part of their tax position.
How HMRC will decide on the employment status of a self-employed worker?
There are certain criteria HMRC use when making an argument for disguised employment status:
Is there direction, supervision and control? – Essentially this looks at the working relationship between the hirer and the self-employed person. Are they free to use their initiative, experience and qualification to achieve the result they are hired to do, or will they need to be micromanaged?
Do they work for other businesses alongside the hirers business? – Or will they solely work for you?
What is the length of the contract? – Typically one that renews month by month with a notice period is a clear sign of employment. How about a fixed term instead?
Do they have the right to substitute themselves if they wish to and send a replacement? – Insisting that they are the only person that can carry out the work is a clear sign of employment unless there is a good commercial reason.
Lack of contract – Often in circumstances where a self employed contract doesn’t exist the default position can be that the worker is an employee.
From reading these criteria it can be assumed that the true status of an employee is very subjective and whether HMRC make a successful case is purely based on the quality of the argument they make and the evidence they hold which can be very hard for them to obtain.
Cost of Converting Your Self-Employed Workers Into Employees
Converting your self-employed workers can be expensive as overall payroll costs of your company will increase due to:
- Employers National Insurance
- Holiday or Sick Pay
- Additional costs for dealing with PAYE and employment law
- Autoenrollment Pensions
- Costs of statutory paternity and maternity leave
Switching self-employed staff over to being permanent employees can be an expensive process as people rarely want to take a pay cut, even if it comes with additional employee benefits like the ones mentioned above. It’s worth considering that just the act of converting them can cause you issues as HMRC can argue that because you can make the conversion, that they were in fact disguised employee all along.
What is an Intermediary?
Sometimes it is possible to hire workers through another company or provider and in that instance providing that the small business exemption for IR35 applies, you can do it without any risk of an enquiry as you’re not the deemed employer.
Other risks in hiring self-employed people
If the Uber Self-employed court case has taught us anything is that employment law rights can be very complicated and especially when it comes to working out if national minimum wage amounts were complied with. Tax and national insurance on self-employment income isn’t the only thing you should be worried about and genuine thought needs to be given to the reasons for creating the arrangement and they should be focussed on commercial flexibility rather that saving money.
Summary
Overall the risk of hiring self employed people in your business is often not as bad as it seems and there is a lot of hype about the consequences of getting it wrong. Your best option is to talk to good accountants and get their advice on the matter, we’re based in Northampton if you’d like to meet us and we can also hold online meetings as well if you live further away. Why not get in touch today and book your free consultation.
Ultimately self-employment status should never be used as a reason to pay workers less or prevent them from achieving a national living wage. While things can look right in tax law, it is still vital to ensure that you are incentivising your team regardless of whether they are a separate legal entity or part of your business.
