The Four Point Plan for Contractors
The Oaktree Four Point Contractor Plan
- Get all new contracts formally reviewed by a competent lawyer.
- Pay for tax investigation insurance.
- Stick to the rules on entertainment, travel and other expenses.
- Keep a diary of when you are treated differently to staff workers.
There are considerable differences in the tax and National Insurance treatment of self-employed people compared to employees. Consider the example of an IT technician earning £30,000 per year. One is employed, the other self-employed.
- The employee will take home 60% to 65% as net pay – from £18,000 to £19,500.
- The self-employed one will take home 75% to 80% – from £22,500 to £24,000.
This difference is reasonable compensation for the commercial and other risks – no paid holiday, no paid pension – self-employed people are generally running compared to employees. However, over the past 20 years many people who believed they were self-employed have faced large tax and NI bills because Her Majesty’s Revenue and Customs (HMRC) have ruled that they were employees and not self-employed. This is known as false self-employment. Certain fields of work have been especially targeted because the proportion of workers claiming to be self-employed is much higher – up to 3 times higher – than average:
- The construction industry has become the subject of a whole new set of rules – the Construction Industry Scheme. This is dealt with in a separate note because these rules are unique to that sector.
- IT consultants and contractors.
- Butlers and nannies and other “personal service” contractors who often work for the same client for several years.
This note is a summary of the key issues for determining whether someone is self-employed or not. This is one of the most complex areas of UK employment law and this note is by no means intended as a cast-iron guide to any given person’s legal employment status.
The Key Tests of Employment
Overall it is the intention and reality of the relationship which matters. HMRC will apply the following tests. The more of the following questions which are answered “Yes”, the more likely it is that HMRC will rule that false self-employment applies:
- Is the customer offering work, and the contractor accepting it, on an ongoing basis?
- Does the customer have control over the hours being worked and the tasks undertaken?
- Does the customer provide all the equipment needed to carry out the contract?
- Does the customer require the contractor to do the work personally? (i.e. he or she cannot send a substitute)
- Is the contractor free from any financial risk or painshare?
- Is the customer paying by the hour or day – as opposed to fixed price or lump sum contracts for specified tasks undertaken?
- Is the customer providing sick pay, holiday pay and other similar benefits?
- Is there an intended employment relationship – as opposed to a stated intent in the contract not to have such a relationship?
- Is the contractor spending the vast majority of his or her time on this customer’s contract?
- Does the contract provide for a fixed notice period?
Whose Problem is this?
After all the above complexities, we get to a simple answer – yours! If you set up a limited company or other business and run a contract or contracts through it on the basis of being self-employed, but it is later determined that it was false self-employment, you are liable for all the PAYE and employee’s NI which you’d have paid as an employee. Strictly under IR35 – the Inland Revenue regulation dealing with this area – you’ll get a 5% deduction from the invoiced value to cover admin. expenses, but if you’ve been taking home 20% more cash than you’d have done as an employee, there could still be a big bill to pay.
Business Expenses for Contractors within IR35
The rule for the self-employed here is that expenses “wholly and exclusively incurred” for business purposes can be deducted from revenue to arrive at taxable income. This means that a wide range of expenses can be deducted.
For people deemed to be employed the expenses must be “wholly, exclusively and necessarily incurred in the course of the employee’s duties”. This is much more restrictive as follows:
- Invoiced cost of meals whilst at a temporary workplace.
- 45 pence per mile for the first 10,000 miles driven, then 25p thereafter.
- Invoiced cost of hotels and the reasonable costs of evening meals.
- Training which is directly relevant to your contract duties.
- Pension – still a big tax break as you save tax and NI if the company pays a pension contribution.
- Subscriptions to a professional body which is on the HMRC approved list.
As an example, if a self-employed contractor decides to go on a training course, there will be no problem with the deduction for tax purposes. But if an IR35 contractor goes on the same course, they probably cannot claim tax relief for the costs incurred – unless going on such courses is part of the contract terms.
If you get a lawyer to review a new contract it costs around £100. This is accepted by HMRC as evidence that a contractor has taken reasonable steps to assess his or her employment status.
Tax Investigation Insurance
HMRC will go back 6 years in IR35 cases. A tax liability per year of £10,000 is not that unusual. This means the HMRC enquiry team is seeking £60,000 in back taxes. Set against that, tax investigation insurance for £90 per year is a total no-brainer. Status enquiries tend to be lengthy and HMRC will happily spin them out, it’s taxpayers’ money they are spending not their own. If you are insured you can match them pound for pound.
Keep a Diary
One Oaktree client was put on a four-day week for two months in 2013. The customer staff who were working on the same project were all kept on full-time. This was unwelcome at the time for my client who was earning 80% of normal pay, but made him ironclad against IR35 for that tax year. The contract said he was not an employee, and not only that he was not being treated like one!
Keep a diary of such events and your accountant can answer any HMRC letters with a robust reply detailing specific examples, not a generic “this contract is one of self-employment” letter.
Don’t take the Mickey!
You’ll no doubt have conversations with other contractors who are claiming:
- Meals out with their spouses.
- Travel to work costs beyond the “24 month rule” period.
I advise people not to do any of this. Remember the “IR35 risk” can be £10,000 per year or £60,000 in total. Suppose you claim lots of restaurant meals with your wife and this reduces your corporation tax bill by £700. Then HMRC come in to review the entertainment expenses. Whilst there, they decide that as you’ve been taking the Mickey on entertainment expenses they’ll open up an IR35 status enquiry. Suddenly you are going to feel very sick!