Employment status

The way you work – and the way people work for you – have very important legal implications.

There are five categories of employment recognised by the law and the tax system. A person could be classed as a self-employed person, a worker, an employee, a director or a contractor.

There are also essential tax and National Insurance contribution (NICs) differences for different categories of employment. As an employer, you must recognise which category the people who work for you belong to, to ensure you fulfil your legal and tax obligations to them.

It should be noted that while an individual’s tax arrangements can be a factor in determining their employment status in relation to employment rights, the fact that HM Revenue & Customs (HMRC) have, for example, taxed an individual as an employee does not automatically determine that person’s employment status.

This guide provides a general overview of the different employment status categories and what they mean.

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Workers and employees

All employees are entitled to employment protection rights – though some rights require a minimum period of continuous service.

A number of core rights, such as the national minimum wage and regulations on working time, including rest and paid annual leave, are also available to the wider category who qualify as workers.

Contracts

A person’s employment status will depend on whether their contract is a contract of employment (employee), a contract for the personal performance of work (worker) or a contract for services (self-employed).

An employee is someone who works for you under the terms of an employment contract. A contract of employment could be written, oral or implied. See our guide on the employment contract.

The category of worker is wider and includes any individual person who works for you, whether under a contract of employment or other type of contract, but is not self-employed. This category can include casual workers, agency workers or some freelance workers but the terms of the contract will determine their employment status.

The law

For the purposes of income tax and National Insurance contributions (NICs), the agency providing an agency worker or casual worker is responsible for operating PAYE (Pay As You Earn) and accounting for NICs for that worker.

If there is a dispute about employment status and employment rights (or taxation), this can ultimately only be decided by the courts. The courts have devised a number of tests which examine the individual’s circumstances and consider all aspects of the relationship – including what a contract may or may not say – to establish employment status.

There are five key tests the courts will consider:

• control – whether you as an employer can instruct them how and which tasks to perform
• integration – whether they are part and parcel of your organisation
• mutuality of obligations – whether the worker is personally obliged to carry out the work and whether you are obliged to pay the worker for the work
• substitution – whether someone else can be sent by the worker to do the job
• economic reality – whether they are in business on their own account, eg where they bear the financial risks of failure to deliver the service or can profit from their own sound management of the task

Recent trends have been towards the application of a ‘composite test’ which takes account of all relevant factors. However, if you are unsure of the employment status of someone who works for you or have concerns, you should seek advice.

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Am I legally classed as self-employed?

Whether you can be classed as self-employed – as opposed to an employee or a worker – often depends on the level of your independence.

Although there is no individual test that is decisive, you’re likely to be classed as self-employed if you:

• have the final say in how your business is run
• risk your own money in the business
• are responsible for the losses as well as profits of your business
• provide the main items of equipment you need to do your job
• could send a substitute or are free to hire other people on your own terms to do the work you have taken on and pay them at your own expense
• are responsible for correcting unsatisfactory work in your own time and at your own expense

You can be employed and self-employed at the same time. For example, you may work for an employer during the day but run your own part-time business in the evening.

You must tell HM Revenue & Customs (HMRC) you are self-employed within three months of the end of the calendar month in which you became self-employed. If you don’t, you could face a penalty.

If you sell your own services through a third party, such as a limited company or partnership, IR35 rules may apply. Special rules also apply to individuals who provide their services through a managed service company. See the page in this guide on IR35 and other special rules.

You should seek advice if you are unsure of your employment status or that of someone who works for you.

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Employment status of company directors

Executive directors of limited companies are classed as office holders for the purposes of tax and National Insurance contributions (NICs). An office holder’s earnings are automatically chargeable to tax as employment income and there is also a liability for Class 1 NICs.

The rules for calculating NICs for directors are different to those for other employees. Class 1 employee and employer NICs must still be paid if the director earns over the primary threshold, but unlike employees, directors are taxed on a cumulative basis. This means that you have to recalculate their NICs every time they are paid – based on their total earnings to date.

For information on NICs for directors, see our guide: employee starts or stops a directorship.

The majority of non-executive directors are also regarded as employed by the company or self-employed under a contract for services, depending on the terms and conditions of their appointment.

However, regardless of their executive or non-executive status, company directors have a number of additional responsibilities under company law and in relation to the completion of self-assessment tax returns. See our guide on company directors’ responsibilities.

Self-employed people who convert their business to a limited company usually become directors of the company as well as employees of the company.

In employment law, a director of a limited company has the status of an office holder. While employees’ rights and duties are defined by an employment contract, the rights and duties of an office holder are defined by the Companies Acts and the articles of association of the company. Office holders are not usually covered by employment legislation unless specifically mentioned.

However, it is not unusual for a company director to also have a contract of employment with the company and so be both an office holder and employee, and therefore benefit from the employment rights of an employee.

You should seek advice if you are unsure of your employment status or that of someone who works for you.

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IR35 and other special rules

There are special rules that apply to contracts where individuals provide their services to a client through a third party, such as their own limited company or partnership. There is also a special tax scheme for contractors and self-employed subcontractors in the construction industry.

IR35

Legislation commonly known as IR35 brings the tax paid on certain contracts in line with the tax paid by employees. As an employer, you do not make deductions for PAYE (Pay As You Earn) or National Insurance contributions (NICs) from payments made under such a contract to an ‘intermediary’.

Contractors and subcontractors in the construction industry

There is a special tax scheme for self-employed contractors and subcontractors working in the construction industry. It does not apply to employees, who should be dealt with under the PAYE system.

Find out about the Construction Industry Scheme on the HM Revenue & Customs (HMRC) website- Opens in a new window.

Managed service companies

A managed service company (MSC) is a form of intermediary company through which workers provide their services to end clients.

All payments received by individuals who provide their services through an MSC are subject to PAYE and NICs. The legislation ensures that all workers operating through an MSC pay tax and NICs at the same rate as other employees.

Where PAYE and NICs debts are irrecoverable from the MSC they can be transferred to third parties. These third parties include:

• a director, or other office holder, or an associate of the MSC
• an MSC Provider, or the director or office holder, or an associate of the MSC Provider
• those that have directly or indirectly encouraged or been actively involved in the provision by the MSC of the services of the individual, or a director, or other office holder or associate of such a person

Read about MSCs on the HMRC website- Opens in a new window.

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