What is the Elective Deduction Model (EDM)?

As readers of LinkedIn posts in the umbrella company sphere will be aware, there is currently a fairly public and heated disagreement between Contractor Voice and the Freelancer & Contractor Services Association (FCSA), in relation to a contract involving FCSA member NumberMill, about what is called the Elective Deduction Model (EDM).

My understanding, writes Roger Sinclair, legal consultant at egos, is that the FCSA’s umbrella code expressly prohibits its members from using EDM, and that may be why an EDM may be considered to be ‘A Bad Thing.’ FCSA certainly don’t sound fond of EDM, here.

It is not my intention in this article, exclusively for ContractorUK, to become involved in or pass comment on that disagreement. Nonetheless, it does focus attention on a rather opaque area -- the EDM -- which surely will benefit from some background and even clarification.

EDM: defining the undefined

To get even close to having enough unbiased information in front of you to be able to have an informed opinion, the starting point must be to establish what an EDM is.

The ‘EDM’ is a term which first came to my attention in 2014, when HMRC’s ‘false employment’ legislation was introduced (despite HMRC calling it the false 'self-employment' legislation). But ‘EDM’ is not, to the best of my knowledge, something for which there is any statutory definition.

Resources that might help, new and old

The English author, poet and master of wordplay Lewis Carrol once wrote:

“‘When I use a word,’ Humpty Dumpty said in rather a scornful tone, ‘it means just what I choose it to mean — neither more nor less.’” (Alice’s Adventures in Wonderland, 1865).

Although an absence of statutory definition for EDM could indeed lead parties to invent what EDM means to them, in circumstances that suit them, that’s not particularly helpful in anyone's understanding.

So instead I decided to ‘phone a friend’. But unfortunately ChatGPT4 didn’t have a clue about the EDM! Trusty Google came up with a few definitions, and, to my mind, the following explanation from tax charity the Low Incomes Tax Reform Group (LITRG), probably resonates best with my own understanding.

What is the Elective Deduction Model?

The Elective Deduction Model, or EDM, exploits the fact that employment law and tax law are different, the LITRG begins. In employment law you have three categories of person - employee, self- employed or 'worker'. In tax law you only have employed and self-employed. Usually people have the same status for both employment law and tax law, however this is not always the case.

LITRG continues: “Self-employed people do not have the rights and protections that ‘workers’ have under employment law (remember agency workers are usually ‘workers’ and are very unlikely to be genuinely self-employed for employment law purposes). Putting workers in these 'EDM' arrangements saves the employment intermediaries concerned money. However, [EDM] is unlikely to benefit you in any way at all (in particular your key rights like minimum wage, holiday pay and auto enrolment are bypassed). As such, you should think very carefully about accepting such terms and conditions.”

Elective, optional? Not in PAYE legislation, it seems

The above expression from the tax charity seems to imply an exercise of electing to be taxed under PAYE -- therefore suffering deductions -- which it seems to suggest that one might also elect (under the same arrangements) not to be taxed (and suffer deductions) under PAYE.

Now, so far as I am aware (and I am open to being told I am wrong in this), either PAYE applies, or it doesn’t -- as a matter of law. I’m not aware of anything in the PAYE legislation which allows for PAYE to be optional. As I understand it, the application of PAYE is a binary result of applying the law to a situation -- either PAYE applies, in which case it must be operated; or it doesn’t (in which case it can’t be operated). Nothing optional or elective about it.

Ready Mixed Concrete, false employment, SDC

Until the introduction of the ‘false employment’ legislation in 2014, whether PAYE applied seemed to depend on whether or not there was (what tax law viewed as) an ‘employment’ relationship between payer and payee. This in turn depended on common law, of which the 1967 ‘Ready Mixed Concrete’ case (which was actually about national insurance, not tax) was the foundation -- where it was held that, if there were:

(a) mutual obligations, on the one part to provide services personally, and on the other part, to pay for such work (often called a ‘wage-work bargain’),

(b) a putative ‘servant’ who is, to a sufficient degree, subject to the control of the putative ‘master’, and

(c) provisions of the contract not otherwise inconsistent with a contract of service,

…then an employment relationship would exist between the parties.

Put another way, the relationship would fall into the category of ‘employment.’

Many (many!) subsequent cases have clarified and/or provided gloss on that definition, but it is probably sufficient for the purposes of this article.

The ‘false employment’ legislation of 2014 addressed what seemed to be an anomaly -- until then, where there was a contractual intermediary between the worker and the person for whom the work was done, it could be argued that the interposition of the intermediary in the contract chain meant that the Ready Mixed Concrete conditions could never be satisfied -- and so that there was no employment relationship, and no obligation to operate PAYE.

The 2014 legislation introduced a requirement for the person paying the worker to operate PAYE in most situations, unless the worker was not subject to (or to the right of) supervision, direction or control (‘SDC’) as to the manner of working, by any person. Notably, whether the arrangement included an obligation of personal service would no longer be relevant -- so a right of substitution in the contract did not avoid the legislation.

Still nothing elective about PAYE…

So, in general terms, where an individual is engaged under a contract by an intermediary which says that (a) the individual is ‘self-employed’, but (b) no none wants to take the responsibility (towards HMRC) of asserting that the worker is not subject to (or to the right of) SDC, the intermediary must operate PAYE, regardless of whether or not there is a right of substitution. There is nothing ‘elective’ about it.

For tax purposes, an individual is either employed, or self-employed.

Employment law, however, recognises a third category of individual – that of a ‘worker’ – whose position lies between that of an ‘employee’, and that of the self-employed. The self-employed don’t, in general, have what may be termed ‘employment rights.’

Don’t forget, a 'worker' does not work under a contract of employment

Workers, however, have some (but not all) of those rights.

The definition of a worker (otherwise called a ‘limb (b) worker’) used for most purposes is that which can be found in the Employment Rights Act 1996, section 230(3)(b) -- it is a person who does not work under a contract of employment, but under:

“any other contract, whether express or implied and (if it is express) whether oral or in writing, whereby the individual undertakes to do or perform personally any work or services for another party to the contract whose status is not by virtue of the contract that of a client or customer of any profession or business undertaking carried on by the individual.”

And, for most purposes, the existence of a right of substitution will avoid an individual falling into the category of a ‘limb (b) worker’ (though it will not necessarily prevent the National Minimum Wage from applying, in the case of those falling within the definition in the NMW legislation of ‘home workers’ -- which definition, oddly perhaps, is likely to include most agency workers working on client’s premises).

Reverting to EDM and LITRG’s suggestion it is exploitative

Going back to the LITRG’s description of the EDM, the description seems to suggest an arrangement where:

• an individual is described as self-employed, if for no other reason than that (s)he has a right of substitution -- and so cannot fall into either the category of an employee, or that of a ‘limb (b) worker, but;
• as a result of the ‘false employment’ legislation, is taxed under PAYE.

And the LITRG suggests that form of EDM to be an arrangement which can lead to exploitation.

Whether or not it does in fact lead to exploitation in any particular case is a different matter, and must remain a matter of opinion.

It’s not just Alice and Humpty Dumpty in ‘wonder’-land

With all the above in mind, one ‘wonders’ how FCSA themselves will choose to define an EDM -- and, whether they will decide that the contract in question, allegedly used by one of FCSA’s member companies falls within the EDM category that the FCSA has proscribed.

As Alice went on to ask Humpty:

“‘The question is,’ said Alice, ‘whether you can make words mean so many different things.’ ‘The question is,’ said Humpty Dumpty, ‘which is to be master — that's all.’”