Changing an individual’s employment status from an employee to a consultant may appear beneficial to an employer. There’s no requirement to pay employer National Insurance contributions and there would be increased flexibility for the individual. So, it’s a seemingly beneficial situation for all involved? Well, not quite.
Our team of employment law specialists cautions that this move could pose a significant risk for the employer. Make sure you understand the difference when considering an employee vs a consultant. Read on to learn more about how you can minimise the risk involved.
The Benefits
Employers may see cost-saving as a significant incentive unless the individual negotiates a substantial salary increase. During a lull in business, an employer may ask an employee to switch to a consultant role to retain their knowledge and expertise without the expenses and obligations of having staff. In certain instances, an older employee may prefer a transition to retirement by working as a consultant, particularly if they possess specialised knowledge that can assist the business. In today’s “virtual” business landscape, entrepreneurs will often depend on a flexible workforce of consultants.
The Risks
Along with the advantages, there are also commercial and legal hazards for employers. Consultants often have a diversified career and work for various companies, including competitors (although well-drafted contracts can assist in safeguarding your business). Unlike employees, consultants may refuse work offers, leading to a loss of dependability. Consultants are less likely to feel as committed or take the same initiative as employees who have a stake in your company, and building client relationships may be more challenging if consultants have a short tenure.
Below, we outline the legal risks, as well as the risks of being targeted by HMRC for misclassifying someone as a consultant.
Employee vs Consultant
The distinction between employment statuses, including employees, self-employed contractors (also called consultants or freelancers), and workers, is complex, and there is no single criterion for classifying an individual.
However, certain factors serve as critical indicators. Employees are required to show up for work and cannot delegate the task to someone else or decline to work. You regulate their work and they are integrated into your organisation. A consultant can reject a project or assignment and may be allowed to send a substitute. Worker status lies somewhere between employee and consultant, where workers must still perform the service personally.
Differences in Employment Contracts
Understanding the difference between employment and consultancy agreements is crucial in reducing the risk of running into trouble with HMRC further down the line.
Employment Contracts
Employment contracts are used to hire individuals for long-term positions within a company. These agreements must comply with employment laws and should outline important details such as the employee’s salary, working conditions, flexible working arrangements, equity incentive plans, probation, and end-of-contract terms. Essentially, an employment agreement is designed to establish a clear and defined relationship between the employer and employee.
Consultancy Contracts
In contrast, consultancy agreements are contracts designed for services provided by independent contractors who are self-employed individuals. These agreements are intended for use when a business requires the services of a consultant for a specific project or a set period. Consultants provide their services for a fee, but they are not considered employees as they do not work for an employer. Instead, they operate on a self-employed basis, providing services to the business that has engaged them. The consultancy agreement should clearly outline the services that the consultant will provide, payment terms, and any other relevant details to the project or period.
How does this affect Employment Rights?
An individual’s employment status determines the extent of their employment rights. Employees have the most comprehensive rights, including family-friendly leave and protection from unjust dismissal. Workers have only a few of the rights available to employees, such as the entitlement to paid leave and the right to receive the national minimum wage. Consultants have very limited employment rights.
Employees vs Consultants Tax
The employment status of an individual affects how they are taxed. The same tests used to determine an individual’s status for employment purposes are used to determine their tax status under the IR35 rules. If an individual is wrongly categorised as a consultant instead of an employee, HMRC may try to recover unpaid tax and National Insurance contributions from both the employer and the employee. Recent high-profile cases, such as the one involving BBC presenters, have highlighted the potential financial risks of getting it wrong.
For instance, in 2019, the High Court ruled that three BBC presenters were employees of the organisation and were liable for a considerable tax bill. The BBC was also ordered to pay approximately £200,000 in national insurance contributions as an employer. David Eaves, Tim Wilcox, and Joanna Gosling had contested HMRC’s classification that they fell “within IR35” but were unsuccessful. Additionally, HMRC was defeated in several tax tribunal challenges in the previous year.
The precise categorisation of an individual as either an employee or genuinely self-employed for tax purposes relies on the specific and unique circumstances of each case. The Check on Employment Status for Tax (CEST), an online tool offered by the government to evaluate an individual’s tax status, has faced criticism for inadequately addressing the legal assessments required.
Since April 2017, public sector organisations have been responsible for determining the tax status of contractors and freelancers under the off-payroll working rules, shifting the responsibility from the individual to the end client. From April 6th, 2020, private sector organisations will also be responsible for applying the rules to their contractors and freelancers. However, the rules will only apply to medium and large organisations, as determined by financial measurements and headcount. Small businesses will continue to operate under the current IR35 rules.
Some large businesses have adopted a blanket policy of only offering work “within IR35” in anticipation of the changes, which some consider overly cautious. Concerns have been raised that this approach may make projects less attractive to consultants unless fees are increased. The government has launched a review of the changes to ensure a smooth implementation, but as of now, there are no indications of any delays or changes to the planned reforms.
Changing a Contract and Changing an Employment Status
Changing the label given to an individual from employee to consultant in the contract does not necessarily change their employment status. If an employment tribunal finds little change in the day-to-day reality of the working relationship, it may look beyond the wording of the contract and form its own view on status. Furthermore, even if an individual appears to accept the change from employee to consultant, they may later claim they are an employee or worker, especially in the event of a dispute or if they feel they are missing out on something such as holiday pay.
Individuals who work as employees and consultants are subject to different tax regulations, and the same tests are used to determine their tax status under the IR35 rules. If the HMRC finds that an employee has been incorrectly classified, they will attempt to recover unpaid taxes as well as employer and employee National Insurance contributions. This has resulted in significant claims from the HMRC in recent high-profile cases, such as the BBC presenters who were deemed to be employees and had to pay a substantial tax bill. Determining an individual’s tax status requires a detailed assessment of their circumstances, which can be complicated. The government’s online tool for assessing tax status has been criticised for being inadequate.
How can I reduce the risks?
To reduce the risks of misclassifying an individual as a consultant instead of an employee, ensure that the contract accurately reflects the working relationship, and regularly review the arrangement to confirm it is still appropriate. Offer work on a project-by-project basis with breaks in between, and pay for services provided, not a fixed salary. Give the consultant autonomy and avoid integrating them into your business. It is also essential to allow the consultant to provide a substitute if necessary. Seeking legal advice from an employment law specialist team can help assess the suitability of the move and draw up an appropriate contract.
We can assess the suitability of moving an employee to a consultant, draw up an appropriate contract and advise you on how to reduce any risks. Please contact our team on info@witansolicitors.co.uk.
Note that this article is for general information only and does not constitute legal advice, and the law may have changed since its publication.
