Contract for employment or services?
Two cases decided in December 2007 could help you defend yourself from a costly tax bill if the Taxman decides one of your contractors was actually an employee. What new angles can you use?
What’s the problem?
Scenario. Self-employed workers can be a ticking tax bomb. If the Taxman decides they should have been treated as employees, he will ask you for the PAYE and NI you should have deducted from their wages, plus employers’ NI due. This tax bill can cover up to six tax years if the “false” self-employed workers have been employed by you throughout that time.
For example. Let’s say you paid a contractor £10,000 in the last tax year (2007/8), but the Taxman has now sent you a bill for £3,480, made up of tax at 22% and employers’ NI at 12.8%, calculated as follows: £10,000 x 34.8% (22% +12.8%) = £3,480. It’s then up to you to prove the Taxman wrong.
Classic solution. You tell your contractors you only deal with companies. So they set one up and bill you through that separate entity or even use an agency between you and their company. The PAYE issue is then between the contractor and the Taxman under IR35 or Managed Service Company legislation (see the article on page 2).
Risk. IR35 rules target the use of intermediaries generally. They can bite where a worker provides services under a contract between you and an intermediary where they, but for the presence of this entity, would have been an employee.
Our solution
Obviously you need to get the documentation right. Ensure that your contract with them: (1) does not include phrases that give the impression that they are under the company’s control; (2) gives no certainty of continuing work. This means that the Taxman cannot contend what is termed “mutuality of obligation”; (3) includes a substitution clause; and (4) does not give them any employee rights such as holiday or sick pay, pension etc.
However, recent case law shows the need to make sure that, not only the documentation, but more importantly the facts, support your view that your freelancers are truly independent contractors. For example, check that they are not listed in the internal telephone list of employees and don’t have rights to attend staff events (other than as an invited guest). They might even have a different security pass compared to company employees.
New angles on the facts
Winners. Two recent wins for taxpayers (First Word Software Ltd v HMRC SpC 652) and (Datagate Services Ltd v HMRC SpC 656) (see The next step for details of both cases) canprovide you with an enlarged comfort zone.
Tip 1. In your agreement with the contractor, make sure there’s no provision for minimum hours, set hours or overtime.
Tip 2. Include the right to assign the rights and obligations of the agreement and/or provide a substitute so long as “suitable security clearance is obtained”.
Tip 3. If the contractor is to work “within a team”, i.e. not independently or on discrete sections of work, record that this was done so staff could learn from the contractor’s expertise - and did so.
The next step
For details of two recent employment status cases, visit http://tax.indicator.co.uk (TX 08.14.06).
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