In a simple world, employment rights and tax would overlap, and a self-employed worker would know for certain how they’d be treated in terms of both.
But we don’t live in a simple world. Two major challenges to the system in 2016 have made that clear.
For tax purposes, we still have a binary system of employed and self-employed. But the Pimlico Plumbers and Uber cases have shown that, for employment law only, there is a third category: that of the ‘dependent contractor’.
It’s also not always clear that people who regard themselves as self-employed will be self-employed for tax purposes. They may have their own company and in fact be a company director.
The government is worried about the imbalance between the tax and NICs burden of the self-employed and employed, and thinks the gap should be narrowed (hence the chancellor’s abortive attempt to raise Class 4 NICs).
This issue will not go away. Self-employed people pay a main rate of 9%, whereas employed people pay 12% and their employers pay 13.8%. The government will need to resolve the discrepancy between the two systems.
The ‘dependent contractor’ is not a new concept; it has been aired in the Ontario courts in some recent Canadian employment cases. The courts established, for employment law purposes, a binary system of either employed or contractor, but with subdivisions in the contractor category of ‘independent contractor’ and ‘dependent contractor’.
A dependent contractor has better termination rights than an independent contractor. So, if having a tripartite system for employment law and a binary system for tax is unsatisfactory, what are the options for tax and NICs?
One fairly radical solution is to amend the rule book for tax and NICs to reflect employment law developments. How might this work? If the Ontario model is followed, the changes would have to be in relation to contractors.
Logically, there is a case for the treatment of independent contractors (the genuinely self-employed) to remain the same, so the dependent contractor would have to be woven into the tax system. For tax purposes, we’d have to carefully define ‘dependent contractor’.
The Ontario case law says such contractors are economically dependent on one customer and probably work exclusively for them (or nearly so). The UK government’s Employment Status Indicator and Employment Status Service tools could help identify them (using principles of supervision, direction and control).
Then we would subdivide the dependent contractor population to reflect working practices:
- workers through agencies or umbrella companies (these could arguably be ignored as they should be on PAYE);
- those who come through personal service companies (PSCs), such as IT contractors; and
- sole traders (such as Uber drivers).
So what’s a sensible way forward? There seems to be little case for changing income tax; it’s NICs that need to be addressed. A separate class of NICs for dependent contractors may work, perhaps by forcing the ‘employer’ to take on some of the burden – say, NICs of 7%. This would be on top of the 9% currently paid by such workers.
For PSCs, this could be payable by the PSC itself (on all remuneration, including dividends). I think we are at an interesting crossroads. The government will need to address the imbalance. We can certainly expect tax changes in the next couple of years.
Michael Steed is co-chairman of the ATT's tax Technical Steering Group and columnist for Accounting Technician magazine.