Any person engaging a worker is required to determine whether that worker is employed or self-employed for tax and national insurance contributions (NICs) purposes. Employment status is notoriously difficult to determine, and the tests developed from case law used to decide this for employment law purposes are different from those used for tax purposes. Each result is highly dependant on the facts and circumstances of each case.
If the worker is an employee, then the employer is required to pay employer's NICs, and also to deduct pay as you earn (PAYE) tax and employee's NICs from the employee's wages.
However, if a worker is self-employed, then a different tax regime applies. Workers typically will deal with their own tax and NICs. Generally, there are tax advantages to self-employed status for both the worker and the company engaging them (the "engager"). The workers themselves pay a lower rate of NICs than employees, and can also make greater deductions of expenses from their income. The engager will usually have a lower administrative burden in relation to tax contributions, except where the arrangements fall within the scope of the Construction Industry Scheme (CIS). If this is the case, an engager may need to make deductions on account of tax from the money that it pays to the worker. These deductions are made on the basis of the worker's status which has been 'verified' by the CIS as 'sub-contractor'. The engager also does not have to pay employer's NICs or pension contributions, nor does the self-employed worker get employment rights such as paternity/maternity leave or protection from unfair dismissal.
As an additional benefit, self-employed workers have greater flexibility in who they work for. This flexibility of the labour force in turn benefits the industry as a whole.
Historically, a greater proportion of workers in the construction industry have been classed as self-employed than in other industries. The Government used the European Labour Force Survey 2007 to identify the significant disparity between the construction industry and other industries. This survey showed that 34% of workers in the construction industry were self-employed, compared to 11% of workers in other industries. Based on this disparity and other HM Revenue & Customs (HMRC) compliance data, the Government suggests that 200,000-400,000 of these classifications are incorrect, which it considers results in an estimated loss of tax and NIC revenue of around £350 million each year.
It believes that a significant number of workers are engaged on the basis that they are classed as self-employed, but that in reality, workers are employees. The Government argues that this is demonstrated by the way that construction work is carried out on a day to day basis. For example, there is often a large amount of supervision and control of a construction worker; an obligation on the part of the worker for personal service; and a lack of financial risk for the worker for the work done. In addition, there are a substantial number of workers who are not claiming a tax deduction for plant, equipment or materials under the CIS, which might be expected from genuine subcontractors. The Government has therefore concluded that workers are being classified as self-employed to gain tax and other financial advantages.
The Government wants to ensure that construction workers engaged in an employment relationship are taxed appropriately for the purposes of income tax and NICs. This will reduce 'lost' tax revenue and also provide workers with an ability to claim Jobseekers Allowance and State Secondary Pension. It also aims to increase the competitiveness of companies who are already compliant with the taxation system in relation to employment status. These companies pay the added costs of PAYE and NICs for their staff and so cannot offer rates to customers which are as favourable as those offered by the 'non-compliant' companies. Therefore, it has proposed legislation which will result in workers being 'deemed' to be employees for tax purposes subject to three limited exceptions.
The new test for 'deeming' employee status would only apply (initially) to the construction industry, and only for tax law purposes. There is no intention on the part of the Government to extend this new test to determine employee status for the purposes of employment legislation. Therefore, workers will not gain employment rights or protections such as unfair dismissal rights simply as a result of this legislation. The Government also intends that these new measures will lead to a more 'appropriate' treatment of workers in the industry, with more widespread employment rights and training, although it is not clear how this would work in practice as they are not gaining employment rights a result of the proposals.
Under the deeming test, a worker would be automatically deemed to be an employee for tax purposes where they work for a person whose main business involves carrying out or commissioning "construction operations" for the purposes of the CIS. However, payments will not be deemed to be employment income where the worker:
- provides the plant and equipment to carry out the job (although if a worker only provides "tools of the trade", then this will not be covered by the exemption);
- provides all of the materials required to complete the job; or
- provides other workers to carry out work under the contract, and is responsible for paying them.
The Government claims that the 'deeming test' is intended to apply only to those workers who would in any case be considered to be employees if the case law tests were applied 'properly and diligently'. However, by excluding "tools of the trade" from the plant or equipment exception, this appears to contradict a previous decision in a case involving HMRC in 2008 determining the tax treatment of a group of bricklayers. The Special Commissioners determined that one of the factors that pointed to self employment status of the bricklayers was that they carried their own hand tools. Therefore, the 'deeming test' is likely to substantially increase the number of workers who will be considered to be employees, as in the past, ownership of tools has been used to indicate self-employed status.
At present, the Government has not indicated when it would intend to legislate to introduce the proposals or when the proposals are likely to come in to force. However, it is suggested it will not implement any proposals until the industry is in a 'stronger position'. As these proposals will increase tax revenue, it would seem likely they will be introduced sooner rather than later.
Consequences: What are the likely effects of these proposals if implemented?
In short, greater tax revenue for the Government and substantially higher financial cost for the construction industry. The Government has indicated that it estimates that the proposals are likely to cost the construction industry £50-60 million to implement, set against a net administrative saving to the industry of around £5 million per year due to making fewer payments through the CIS. However, the additional administrative burden of establishing PAYE schemes and ongoing compliance costs will have a greater impact on small businesses.
It seems inevitable that these extra costs will be passed on to the worker without the worker receiving any employment rights to compensate. The take-home pay of workers may fall to take into account the extra tax, NICs and compliance cost of the changes. Workers will also lose out by being unable to make additional deductions of expenses against tax.
As these proposals only intend to affect employment status for tax purposes, workers will have the tax disadvantages of being an employee but none of the benefits in terms of employment rights. As a result, employers may also see a rise in the number of claims from current "self-employed" workers for employment status. If this happens, this would also result in additional cost for the industry and potentially an increase in employment tribunal claims.
It is widely accepted that the case law tests determining employment status are uncertain and difficult to apply. Introducing this legislation would provide more certainty, but having only three criteria on which to determine the outcome may be over-simplifying a complex situation and ignores other factors which may be equally important: e.g. the length of the engagement; the intentions of the parties; and the nature of the trade. The Government's consultation focuses, in particular, on whether the tests it is proposing are appropriate.