Contractors' Questions: What rules or taxes apply if we hire contractors?

Contractor’s Question: If we hire a freelance professional does the hirer have to pay Employee National Insurance, or other taxes?

And what are the differences in the tax liabilities or implications if I hire the person as a sole trader, or as a limited company?

Finally, is there any HMRC concession or easement in the requirements or liabilities if we were to hire a group of freelancers or contractors, as opposed to just one?

Expert’s Answer: A business has to deduct payroll taxes, incurs liability to Employer NICs either when an individual is engaged directly as an employee, on a Fixed Term Contract or where IR35 applies.

This is all concerned with the appropriate levying and collection of taxes and as such, there is no easement or concession for engaging more freelancers.

You don't ask directly about IR35, but...

You will need to be aware of the Intermediaries legislation (IR35) whenever you engage with resource on a flexible basis. But that does not always mean that IR35 will always apply.

The clue is in the name. The Intermediaries legislation seeks to identify where an individual working through an intermediary acts and is treated like an employee. The legislation says that where that is the case, such individuals should be taxed in the same way as an employee (i.e. income tax and NICs being deducted before payment is made).

Where IR35 applies

The legislation then applies to those trading through an intermediary -- this could be a limited company, a limited liability company or partnership. Anyone trading as a sole trader is engaged directly with their client and so IR35 cannot apply.

Thought should be given though to employment law and whether that person acts and is treated more like an employee than an external resource.

A recent case saw Uber drivers awarded employment rights after a tribunal ruled that those drivers were more akin to employees than self-employed drivers. The reasons given were that Uber:

• Set the rates, disabling the drivers from being commercially independent,
• Enforced their star rating system effectively telling their drivers how to deliver their service and that once an Uber driver logged on, their was an expectation that Uber would find work for the driver and that the driver would accept it.

If you are comfortable that any sole traders you engage with are genuinely self-employed and neither act nor are treated like employees, then you (the hirer) have no responsibility to deduct taxes, nor will it incur liabilities for Employers NICs.

Small, medium or large?

Other than sole traders, it’s most likely that you will engage with individuals trading through limited companies. Where that is the case you should firstly consider whether the hiring company is a small, medium or large business according to Companies House’s definition. If the hiring company meets the ‘small’ company definition then the responsibility for determining status under IR35, and the liability to tax should the determination be incorrect, sits with the individual being contracted -- and not the hirer.

If that’s the case then you can stop reading now! But if it isn’t the case and you (as the hirer) are a medium or large company, then you’ll need to be aware of the factors that determine status under IR35, so that you can provide a Status Determination Statement. An SDS sets out whether you (the hirer) believe that IR35 applies to the engagement, or not, and why.

There are many factors that affect a status determination but the main three are:

Substitution

This effectively asks whether the individual providing the services can be determined by the intermediary or not. If not, then it follows that the person providing the services is likely always to be the primary director and (often) sole shareholder (in the case of a limited company intermediary).

The more freedom the intermediary has over who provides its services, the less likely that IR35 can apply.

Control

This test looks at how the individual providing services through an intermediary works. Are they able to apply their own methods and processes or are they told how to do their work?

The more prescribed the role, the greater the chance that IR35 applies (also known as being ‘inside IR35’).

Mutuality of Obligations (MoO)

This examines the extent to which each party is obligated to the other. In a true employment situation, an employer will be bound to find and offer work to an employee and the employee will be bound to accept such instructions.

The less either party is obliged to find, offer or accept work, the less likely that IR35 will apply.

Incidentally, we can draw comparisons to the Uber case with all three of these main tests and understand how they can be used to determine employment status -- or -- in the case of IR35, ‘deemed’ employment status.

What tax you'll pay is determined by IR35 status

If all three tests are met (i.e. the individual cannot appoint a substitute, is subject to the control of their client with regards to how they carry out their duties and MoO exists), then it is likely that IR35 will apply and in those instances, income tax and Employee NICs will need to be deducted before payment is made to the intermediary.

The hirer will also incur an Employers NIC liability. Note, this cannot be offset against the agreed day rate which the worker is paid, unless that was part of the negotiations and agreed on by all parties.

Five options

Your options in that case would be to engage with the intermediary and deduct taxes before making payment, engage with the individual through an ‘umbrella company’ arrangement, permanent employment or an FTC. Or fifthly, if none of those four options appeal, speak with an IR35 expert to explore ways to engage the intermediary compliantly so you can be able to assess the engagement as being outside IR35. Good luck!

The expert was Patrick Gribben, head of client services at contractor accountancy firm Intouch Accounting.