Contractors will often be in a better position if they are self-employed. They will typically pay less tax, although the main motivation is usually that they will receive gross funds without having to pay their tax immediately.
However, its important for agencies to be aware of the risks they take when paying workers as self-employed. These are usually where HM Revenue & Customs (HMRC) believe their employment status is not self-employed and look to the agency for PAYE and NIC.
Agency legislation
In the Income Tax (Earnings and Pensions) Act 2003 (ITEPA) s44 states in relation to the ‘treatment of workers supplied by agencies’ that
“all remuneration .. is to be treated .. as earnings from that of employment.”
(ie. subject to PAYE and NIC).
Employment status
Even if for some reason HMRC agree that you are not an agency for the purposes of this legislation (which is extremely unlikely), then they can still review the worker’s employment status. Employment status is defined by the working conditions of an individual contract or assignment, not the worker’s previous status. If your local PAYE inspector decides one of your ‘self-employed’ workers is actually your employee, HMRC will probably charge you PAYE/NIC costs of around 45% of the amount that you have paid the worker, plus interest and penalties.
HMRC are not the only ones who can challenge employment status. Workers often fail to set aside sufficient funds to pay their future tax and NIC and decide to challenge their own employment status.
This also happens when there are issues around redundancy, sick pay, holiday pay or accidents. There is growing evidence that accountants are now advising workers, who are unable to cover their end-of-year tax bill, to claim against their agency, demanding they are treated as employees.
Use of an intermediary company
Sometimes contractors work as self-employed through an intermediary company, so agencies receive invoices from a limited company. This initially looks much safer for agencies, however the 2007 ‘Managed Service Company’ (MSC) legislation meant that not only would workers paid through MSCs be liable to be taxed as employees, but that agencies could be liable for unpaid tax where HMRC cannot collect the tax from the worker or the MSC. This problem is often linked to the HMRC ‘Construction Industry Scheme’ (CIS) – the MSC legislation applies to all service work, whether in construction or not. HMRC have already stated that they are focusing on ‘false’ self-employment in construction – see our recent article here. One construction company is reportedly facing a bill of several million pounds for unpaid PAYE and NIC going back several years.
Client Requirements
Often clients (especially larger multinationals or blue-chip clients) require that all workers are properly taxed and under employment contracts. This helps protect them from future liabilities.
Summary
In light of these risks, many agencies adopt a policy to pay only compliant umbrella companies, or in some circumstances, contractors’ own limited company (although MSC risks still apply). HMRC have stated that they believe agencies have a duty to check the compliance of their labour suppliers and will hold them accountable where they fail to do so.
