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Self’s assessment: employed or self-employed?

Partner Heather Self examines tax issues which make the national headlines. This week, employed or self-employed? That is the question.

When PAYE was introduced in 1944, the world of work was relatively simple. Most people were employed in factories or offices, or were self-employed professionals or tradespeople. While employees still make up the majority of the workforce (around 85%, per the IFS in 2017), an increasing number of people have second jobs, work part-time, or are in the so-called ‘gig economy’. It is becoming increasingly difficult to determine whether someone is employed or self-employed, and yet the tax system persists in trying to do so.

Twenty years ago this year, IR35 was announced in Gordon Brown’s 1999 Budget. With a heading that the intention was to ‘counter tax avoidance by use of so-called personal service companies’, this was firmly badged as an anti-avoidance measure. The title IR35 refers simply to the fact that this was press release number 35 in the Inland Revenue’s list of Budget announcements. It came into force in April 2000, but crucially placed the burden of compliance on the personal service company (PSC) itself, rather than on the ultimate engager. I chaired the CIOT technical committee at the time, and coordinated the professional bodies’ responses: we felt strongly that putting the onus on the engager would have been difficult, if not impossible, to implement in the timescale available. It may well have been that we were wrong in this, as experience since then suggests that it is no easier for the PSC itself, and that the level of uncertainty continues to be a problem. Furthermore, HMRC considers that there has been significant non-compliance: its review of the operation of the IR35 rules in 2015 estimated that less than 10% of those who should have operated the rules were actually doing so.

Since April 2017, the public sector position has changed to place the obligation on the public authority which engages the worker, and there are proposals (currently out for consultation) to do the same for the private sector from April 2020. Anecdotal evidence suggests that the 2017 changes have made it harder for the public sector to attract contractors (since the public authority is inclined to reduce its risk by taking people onto the payroll, while the contractor may prefer to work for the private sector through his or her PSC).

Standing back from the detail, a large part of the underlying issue is the difference in NICs between the employed and self-employed.

Two recent cases, both involving TV presenters, demonstrate just how hard it is to draw a clear line between those who are operating under a ‘contract of service’ (an employee) and those who are self-employed under a ‘contract for services’. Christa Ackroyd, an experienced journalist and presenter of BBC’s Look North, was held to be an employee ([2018] UKFTT 69 (TC)), but Lorraine Kelly, lead presenter on Daybreak and Lorraine, was held to be self-employed ([2019] UKFTT 195 (TC)). While every case turns on its own facts, the nuances in these two cases are subtle indeed. (It is understood that the Christa Ackroyd case is being appealed to the Upper Tribunal.)

Standing back from the detail, a large part of the underlying issue is the difference in NICs between the employed and self-employed. Employer’s NICs, at a rate of 13.8%, are only applicable to those who are employees, and the IFS calculates that this subsidy amounts to £1,240 per self-employed person per year, or around £5bn a year in total (according to 2017 figures). The difference in NICs was, arguably, justifiable when the self-employed had much lower benefit entitlements, but with the introduction of the new state pension the calculation is much less clear.

While those who are genuinely self-employed bear different risks than those who are employees, the tax system is probably not the best way to compensate for those risks. If the total tax and NICs burden were similar, the choices made by both contractors and engagers might be different, and there would be much less ‘tax-motivated’ choice of vehicle. Other issues need to be addressed as well; some of those who are treated as self-employed would much rather be employed, with the security that provides in terms of worker’s rights. Indeed, recent employment law cases have made it clear that an individual may be a ‘worker’ for employment law purposes, but still be self-employed for tax. Surely then it is time to have a single system?

I’d like to put forward two, fairly radical, suggestions. The first is that an amount equivalent to employer’s NICs should be imposed on some self-employed earnings. A good place to start (because it covers some of the highest-paid) would be professional partnerships with more than 20 members. This would include, in particular, the large accounting and legal partnerships (but not, I should disclose, my own employer which is a limited company). Over time, this could be extended to other self-employed earnings, perhaps above a relatively high threshold, so that gradually the NIC gap would narrow.

The second is that there should be something akin to the construction industry scheme (CIS) applied to payments to contractors: a flat rate of withholding tax, perhaps set at 20%. Effectively, this would replicate PAYE to a large extent, and so reduce the risks of non-compliance; it would also help the cashflow of those who struggle with the obligations of self-assessment. Those who want to establish their self-employment status and are compliant with their tax obligations could, of course, apply for gross payment status.

Neither of these proposals goes as far as the obvious, but politically impossible, solution of fully aligning the tax and NICs rules for all ‘earned income’. But the current situation leads to risks, for both contractors and (increasingly) those who engage them, which are hard to manage. Continuing to try to apply poorly-defined rules to an ever-larger population is surely not a good way to run a tax system.

First published in Tax Journal on 5 April.

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