As an employer, is hiring a freelancer the same as hiring a contractor?
Hiring self-employed freelancers is a great way to add extra capacity and expert skills to your organisation.
Rewards, but risks too
But engaging such non-employed workers can come with risks and the potential for underpaid taxes, and this unfortunately applies to both sole trader workers and limited company contractors, writes chartered accountant Helen Christopher, chief operations officer at Orange Genie Accountancy.
Firstly, be aware that if you engage a freelancer for occasional pieces of work, HMRC is unlikely to pay much attention but if the work becomes regular, or you hire them on a contractual basis, you could attract HMRC’s interest.
If HMRC considers your freelancer to be employed rather than self-employed you can find yourself liable for the PAYE tax and National Insurance Contributions (NICs), and potentially interest and penalties -- should HMRC look back at previous years of the engagement.
No statutory definition of self-employment
Problematically perhaps, the law doesn’t define “self-employment” or “employment.” So it is the particular terms and conditions of the engagement that a sole trader or limited company worker undertakes that will determine their status for tax purposes.
If your freelancer is engaged under a “contract of service,” then they will be an employee and PAYE would apply. Only the genuine self-employed should be paid outside of the PAYE system and they would be engaged via a “contract for service.”
As the engager, you must be certain of your freelancer’s status based on the current terms and engagement. The fact your freelancer states they have always been self-employed is irrelevant. The risk of underpaid tax sits with the engager and as such, you should minimise your risk by undertaking your own ‘due diligence.’
Contract 'for' service, or 'of' service?
While current legislation in the UK also does not define a “contract for service” or a “contract of service”, a body of case law has evolved over the years which has identified the key factors to be taken into account when determining if an engagement is one of employment or self-employment.
Similar (but not the same) to the IR35 off-payroll regime governing the engagement of limited company contractors, the following factors provide a quick guide as to key indicators that will be considered:
The freelancer has the right to hire other people to carry out the work or to work with them. Those individuals would be answerable to, and paid by, the freelancer.
The worker must provide the services themselves, personally.
The freelancer has the right to decide how the work is to be carried out, and when it will be done, as long as this is within the overall project deadline.
The engager will likely control the ‘what,’ ‘where,’ ‘when’ and ‘how’ of the work.
Provision of own equipment
The freelancer supplies the small tools and materials required for the work. They will normally bring in or hire larger items of plant and machinery, if required.
The worker will supply no significant equipment or materials in order to undertake the work.
The freelancer quotes on a job-by-job basis and is paid an agreed amount per job, regardless of how long it takes. They are able to make more money by efficiently working, or may incur a loss if a job overruns or they need to make revisions.
The worker runs no financial risk. They are paid whatever work is done and they benefit from statutory rights and benefits.
Determining the employment status of your freelance worker (whether limited company or sole trader) can be complex.
CEST? It can help...
HMRC created an online tool called Check Employment Status for Tax (CEST), primarily to assist in making status assessments for limited company contractors. But this tool can be built into your engagement process for engaging sole trader freelancers, as it asks a series of questions focusing on the employment indicators flagged in the table above.
Interestingly, under IR35 (which does not affect sole traders), if the contractor is determined to be inside IR35, you -- the engager -- will be liable to deduct basic rate tax from the net value of any invoices that you pay.
Then, the contractor could later offset the tax deducted from their overall liability when reporting their income for the year. In this scenario, the contractors’ earnings are all deemed to be salary.
Reasonable care, liability, and CEST shortcomings
Should the contractor be outside IR35, then you as the engager has no responsibility to deduct any taxes, and the contractor determines how to reward themselves. But all parties should be aware, if HMRC were to disagree with the IR35 status of the worker in the future, and they sought to treat all earnings as salary, the engager may be liable for apparent underpaid PAYE and NICs, if this cannot be recovered from the contractor. In addition, engagers of limited company workers may find themselves liable if they did not correctly apply ‘reasonable care' when determining IR35 status, or if they failed to pass their determination through the supply chain.
As to self-employed workers operating as sole traders, such freelancers pay tax at 20% and 40% on their earnings -- just like employees, depending on the levels earned. Unlike employees, they don’t pay Class 1 NIC and Employer’s NICs are not due (although sole traders do pay Classes 2 and 4 NICs). And further in the case of a self-employed freelancer, the engager may become liable to Employer’s NICs, if the self-employed status of the worker is called into question.
As mentioned, CEST can theoretically be run by engagers or workers to help keep that calling into question at bay, by deciding status correctly.
Be aware, though, CEST does have some shortcomings. And further factor in -- HMRC will only stand by the status result which CEST churns out, if the questions have been answered accurately and truly reflect the working practices and contractual nature of the relationship.
Finally, a warning
Ultimately, if you engage a freelancer on an ongoing basis, getting the employment status position wrong can have disastrous consequences for your business, if HMRC successfully reclassify your freelancers as employees. When in doubt, consult a status expert or adviser.