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Business Services  •  Business Tax  •  HMRC  •  Personal tax  •  Small Business  •  Taxation

Mistakes over freelance ‘status’ can be costly for business owners

By RJP LLP on 29 October, 2013

One of the trends to emerge following the economic downturn has been the changing attitude amongst business owners towards using freelance workers. Whereas in the past, they would have been more likely to recruit permanent staff to support any expansion plans, they are now less likely to make such a long term commitment.

Forced to become more agile and flexible in order to compete, business owners are increasingly defining business operations by specific projects rather than continuous activities. This means they can more carefully control and monitor their outcomes. Working this way means a wider range of specific skills are needed, which are typically more than a single individual can provide. Freelancers provide an immediate source of specialist skills and are also more cost effective. They are often experienced enough to make an immediate impact and the company using their services does not incur the costs associated with employing permanent staff.

Freelance working is a multi billion market
Industry analysts have dubbed this trend the rise of the ‘contingent worker’, whereby business owners are turning to a wide pool of talent which can be called upon as required to undertake specific projects. Very often they use online freelance marketplaces to source skills needed. It is estimated that globally, $300 billion worth of freelance labour is purchased by businesses each year, and this is tipped to increase as greater numbers adopt this way of working.

Why doesn’t HMRC like freelancers?

Employers act as agents for HMRC in deducting PAYE tax and employee national insurance contributions from employees’ salaries and paying these to HMRC on a regular monthly basis. In addition, employers have a liability to pay employers’ national insurance contributions on employee salaries, which significantly increases the tax-take.

If freelancers are treated as self employed, the regularity and amount of tax payable decreases, because not only do they pay their tax bi-annually, with lower amounts of national insurance contributions being payable, but unlike employees they are able to deduct certain business expenses in arriving at the taxable amount. In addition it is more difficult to control the amount of direct tax they pay because they are often working through a limited company.

Whilst these differences enable freelance workers to benefit from lower rates of tax, they do of course face the increased risks of being without work at short notice, and they do not have the same protection that employment legislation provides to employees.

What are the tax implications of status mistakes?

We have identified a number of instances recently where clients have misunderstood the risks surrounding freelance workers who should be on the payroll and have mistakenly considered that a casual worker has self employed status.

If HMRC undertakes a PAYE enquiry and as a result identifies freelance workers who have been treated as self employed, but who in their view should be treated as employees, in the case of self employed freelance workers they will approach the employing company for underpaid tax and national insurance contributions, plus interest and penalties, or they will invoke the IR35 legislation in the case of workers using their own limited company to provide their services.

The result can be very costly, not least because it often involves treating the payments made as net amounts, and grossing them up in order to arrive at the outstanding liabilities.

It is therefore important to be aware of the criteria involved in establishing whether a freelancer is self employed or should be treated as an employee. The table below outlines a number of areas HMRC will consider; no one area is conclusive and it will often be the weight of the different areas which will be conclusive.

Casual worker / employee status Freelancer / contractor / consultant
Works from the client’s premises and the nature of the work requires them to be present to complete their work Undertakes  work from own premises 
Uses client’s equipment to conduct work e.g. laptop Provides own equipment to complete work e.g. laptop, phone
Works exclusively for a single client as sole source of income Provides services to more than one client concurrently
Required to work set hours/ times according to client’s business needs, either on a regular or ad hoc basis Undertakes work in own time at own discretion 
Unable to delegate work to another individual as a substitute Has the right to substitute another individual to undertake the work
Set entitlement to lunch breaks during the working day Does not work from client’s office routinely; works autonomously
Contract specifies nature of relationship as ‘employment’ Does not receive holiday/sick pay or any benefits in kind
Paid according to hourly, daily or monthly rate Paid a job rate, therefore has risk and reward
Works under the direction of the client Incurs expense of rectifying mistakes as a business risk
Provides own professional indemnity insurance

To accurately identify whether a freelance worker will be viewed as an employee by HMRC, you can complete an anonymous online assessment, the Employment Status Indicator via the HMRC website at http://www.hmrc.gov.uk/calcs/esi.htm.

For more information or to discuss status issues in general, please contact Anne Eager, ae@rjp.co.uk.

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