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UK government considers statutory test of employment status for tax

A statutory test of employment status for tax purposes is being considered by the UK government, which is asking for views in a consultation document.12 Feb 2018

The consultation also considers a statutory test for employment rights purposes and whether the test for tax purposes should be aligned with the test for employment law purposes. It also explores whether the current test should be simplified and whether 'workers' should be subject to employment taxes.

"An employment status test which is easier to apply will be welcomed by employers," said Chris Thomas, an employment tax expert at Pinsent Masons, the law firm behind Out-Law.com. "Many employers find themselves on the wrong end of HM Revenue & Customs employer compliance reviews just because they haven’t properly understood or applied the current tests or because the inherent ‘greyness’ leads to different interpretations."

The consultation follows the Taylor review, which made recommendations in July 2017 for changes to employment laws and practices to better reflect modern working patterns. The consultation on employment status was published alongside the government's  response to the review, with three other consultation papers exploring how best to give effect to the review's recommendations.

One of the Taylor review's recommendations was that the government should "replace the minimalistic approach to legislation with a clearer outline of the tests for employment status.”

"If the government decides to change the test for tax purposes, it is not clear whether or how this would apply in relation to existing employees. It could cause havoc in some sectors if employers have to reassess the status of all their existing staff based on new tests. If not, then running two parallel systems would be complex," Chris Thomas said.

For employment rights, there are two main employment statuses: employee and worker. All employees are workers, but not all workers are employees and workers who are not employees have more limited rights. These include paid holidays and to be paid the minimum wage but workers do not have other employment rights such as the right to maternity leave or the right not to be unfairly dismissed. Recent 'gig economy' cases in the courts, such as that involving Uber drivers have centred around the distinction between workers and the self employed, who have no employment rights. 

For tax purposes the only relevant distinction is between employees and the self employed, with workers who are not employees being treated as self employed, so that tax is not deducted under the PAYE system and their engager does not pay employer's NICs.

There are currently separate pieces of legislation defining employment status for employment rights, income tax, and national insurance contributions (NICs).  In each case the legislation ultimately relies on whether a 'contract of service' exists, but this is not defined and so over the years the courts have interpreted the legislation and developed tests to determine employment status. The case law is sometimes interpreted differently for tax and employment purposes.

The document asks for views on whether the main principles should be set out in legislation and whether this would be appropriate for both employment rights and tax purposes. It also asks whether mutuality of obligation, control and personal service should be the main factors codified in the legislation and what these mean in the modern labour market. These three factors have been regarded by case law as key considerations for determining employment status.

The consultation document asks whether additional factors should be codified in the legislation. These include the financial risk taken by the individual, whether the individual is 'part and parcel' of the organisation, whether the individual provides equipment and what the parties intend their relationship to be.

The consultation also considers whether the test should be more precise, perhaps focusing on objective criteria such as length of engagement, or whether it should incorporate a range of criteria, like the statutory residence test. It says that the test could be made less complex test by reducing the number of factors to consider. This is the approach taken by the US and Germany.

"Any attempt at simplification will inevitably give rise to its own distortions and if concepts such as ‘control’ are retained, which they probably need to be to have a well-rounded and equitable test, the simplification may not be that simple," Chris Thomas said.

Some commentators have suggested that the employment and tax definitions of an employee should be aligned as having the same terms meaning different things across employment rights and tax can be problematic. However, others have pointed out that the two systems are trying to achieve different objectives, with one deciding who is entitled to certain employment rights and the other determining the tax regime that applies to the income they receive. The document asks for views on alignment of the tests.

Chris Thomas said: "There is certainly merit in aligning the tax and employment law tests, as the minor disparities between the two increase confusion, so one statutory test should make it easier for businesses".

The Taylor review recommended that the tax regime that currently applies to employees should instead apply to individuals who are either an employee or a worker or 'dependent contractor for rights'. The consultation asks for views on this, "while recognising the significant challenges that this approach would pose and respecting the clear commitments the government has made".

"It sounds as if the government is lukewarm about the idea of extending the boundaries of employment tax to include workers. They are consulting on it, but seemingly more for completeness rather than with the expectation of making changes," Chris Thomas said.

"There is certainly a case for alignment as in the modern age there is no obvious reason why different groups should be taxed differently and it creates incentives to misrepresent status. But it seems unlikely that they will proceed with this, given how controversial it would be and the potentially far-reaching implications," he said.

The Taylor review also recommended that the difference between the NICs of employees and the self-employed should be reduced, but the government ruled this out as part of the 2016 Budget.