This is a chapter from the Bloomsbury Professional book National Insurance Contributions 2011/12, which is a guide to the National Insurance system. It covers National Insurance rates, the categorisation of earners and the impact of EC Regulation. The author also considers the end of contracting-out for defined contribution schemes from April 2012 and the possibility of future reform to National Insurance, particularly its integration with income tax.
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Table of Contents
2.1 Different categories of persons pay different classes of National Insurance contributions. The employed and their employers pay Class 1 National Insurance contributions. The self-employed pay Class 2 and Class 4 National Insurance contributions. Class 3 National Insurance contributions are voluntary contributions which may be paid by earners and others to make up shortfalls in contribution and protect benefit entitlement. The 'cost' of the contribution varies from class to class and the different classes confer very different state pension and benefit entitlements.
As a result of this structure it is very important that an earner is correctly categorised for National Insurance purposes. If an earner is wrongly categorised, for example as being self-employed when in reality he or she is an employee, the earner will pay the wrong class of National Insurance contribution. This may affect his or her state pension and benefit entitlement as well as the amount that the earner pays by way of contributions.
2.2 The legislation (SSCBA 1992, s 2(1)) recognises two categories of earner – employed earners and self-employed earners.
An employed earner is defined as 'a person who is gainfully employed in Great Britain under a contract of service, or in an office (including elective office) with general earnings'.
A self-employed earner is defined as 'a person who is gainfully employed in Great Britain otherwise than in an employed earner's employment (whether he is also employed in such employment)'.
A person can simultaneously be an employed earner and a self-employed earner if he or she has earnings from more than one source.
The primary legislation (SSCBA 1992, s 2(2)(b)) also makes provision for regulations to be made deeming certain earners to be treated in a particular way. The Categorisation of Earners Regulations 1978 (SI 1978/1689) fulfil this purpose and prescribe how certain earners are to be treated for National Insurance purposes. These are examined in more detail at 2.30.
The legislation (SSCBA 1992, s 2(2)(a)) also permits the making of regulations to take certain prescribed employments outside the liability to National Insurance contributions.
2.3 National Insurance contributions may be paid by persons who are not earners.
Secondary contributors pay secondary Class 1 National Insurance contributions. These are also known as employers' National Insurance contributions. The definition of 'secondary contributor is found in SSCBA 1992, s 7(1).
'A secondary contributor, in relation to a payment of earnings to or for the benefit of an employed earner is
(a) in the case of an earner employed under a contract of service, his employer;
(b) in the case of an earner employed in an office with general earnings, either
(i) such person as may be prescribed in relation to that office; or
(ii) if no such person is prescribed, the government department, public authority or body of persons responsible for paying the general earnings of the office.'
It may not always be easy to identify the secondary contributor, particularly where the earner is paid by more than one person in a particular week or if the person works under the control or management of a person other than the immediate employer.
Where an earner is deemed to be an employed earner by regulations, the associated secondary contributor is also prescribed by the regulations (see 2.32ff). The regulations also set the secondary contributor in other cases (see 2.40).
Class 3 contributions may be paid by 'others' as well as by earners. 'Others' are persons who are not earners. Class 3 contributions are voluntary contributions which may be paid to make up shortfalls in a person's contribution record.
2.4 As noted above, different categories of earner pay different classes of National Insurance contributions. The legislation categorises earners into employed earners and self-employed earners.
To ensure that an earner is correctly categorised it is necessary to determine the status of a worker.
Although in many instances it will be clear as to whether a worker is employed or self-employed, this will not always be the case. It is therefore necessary to understand the difference between an employed earner and a self-employed earner and how to distinguish between the two.
Whether an earner is an employed earner or a self-employed earner is a question of fact rather than choice. The nature of the engagement will determine the worker's status. The worker and the engager cannot simply agree that the worker will be treated as self-employed if the nature of the engagement is one of employment.
Where a worker has more than one job, status must be determined separately for each job, having regard to the factors relevant to that engagement. The fact that a worker is an employed earner in one job does not automatically make him or her an employed earner in any other jobs that he or she carries out. Each case must be considered separately on its facts.
The same considerations apply to determine the status of the worker, regardless of whether the worker is working on a part-time or casual basis.
2.5 The statutory definitions of employed earner and self-employed earner applying for National Insurance purposes are set out at 2.2.
Broadly, an employee is someone who works under a contract of service whereas the self-employed work under a contract for services. If it is not immediately apparent which camp a worker falls into, applying certain tests and asking certain questions should enable a decision to be made. The tests of employment and self-employment are considered at 2.7.
2.6 The definition of an employed earner also includes office holders. An office has an existence that is independent from the person holding that office. Examples include Members of Parliament, company directors, government ministers, mayors, etc. However, for the office holder to be an employed earner, he or she must have general earnings. If the officer holder has no earnings, there will be no liability to Class 1 National Insurance contributions as the liability is earnings-related.
2.7 To decide whether a worker is employed or self-employed, it is necessary to consider a number of questions. The following questions, which are included in HMRC guidance on employment status published on their website (www.hmrc.gov.uk/employment-status/index.htm#1) will give an initial indication as to the status of a worker.
2.8 If it is possible to answer yes to all of the following questions, the worker is probably employed.
Do they have to do the work themselves?
Can someone tell them at any time what to do, where to carry out the work or when and how to do it?
Can they work a set number of hours?
Can someone move them from task to task?
Are they paid by the hour, week or month?
Can they get overtime or bonus payments?
Example 2.1
Susie works as a marketing administrator for a large company. Her working hours are 9am to 5pm with an hour for lunch. She is provided with a computer and with the other equipment necessary for her to do her job.
She is paid a salary of £20,000 a year, which is paid monthly in arrears. Occasionally, she is required to work overtime, for which she is paid.
Her duties are set out in her job description. She is given work by her boss, who oversees what she does.
Susie exhibits the characteristics of employment. It would be possible to answer 'yes' to the above questions in relation to her work. She is an employed earner for National Insurance purposes and is liable to pay primary Class 1 National Insurance contributions. Her employer is liable for secondary Class 1 National Insurance contributions in respect of her earnings.
2.9 If it is possible to answer yes to the following questions, the worker is probably self-employed.
Can they hire someone to do the work or engage helpers at their own expense?
Do they risk their own money?
Do they provide the main items of equipment they need to do their job, not just the small tools that many employees provide?
Do they agree to do a job for a fixed price regardless of how long the job may take?
Can they decide what work to do, how to do it and where to provide the services?
Do they regularly work for a number of different people?
Do they correct unsatisfactory work in their own time and at their own expense?
Example 2.2
Mark is a painter and decorator. He agrees to decorate a living room for a client and charges a fee of £600 for the job.
He provides the necessary equipment and purchases trade paint for the job.
He budgeted on the job taking three days. However things do not go as planned and it takes four. He absorbs the cost of this overrun.
The following week, he paints the exterior of a house for a different client. He charges £800 for the job.
Mark exhibits the characteristics of a self-employed worker and can answer 'yes' to the self-employment questions above. He would be regarded as a self-employed earner for National Insurance purposes and would need to pay Class 2 and Class 4 contributions.
2.10 The nature of a person's work may be such that it exhibits some characteristics of employment and some of self-employment. Where this is the case, it will not be possible to answer yes to all of the employed or self-employed questions.
There is no single satisfactory test that can be applied to determine whether a person is employed or self-employed. Where the position is not clear-cut, it is necessary to consider all the factors that are present or absent in the case in point and then to stand back at look at the bigger picture to see if the worker tends towards employment or towards self-employment.
In reaching a decision, there are various factors that need to be considered. These include:
the nature of the contract and other written terms;
personal service and right of substitution;
mutuality of obligation;
right of control;
provision of own equipment;
financial risk;
opportunity to profit;
length of engagement;
extent to which the worker is part and parcel of the organisation;
entitlement to employee-type benefits;
right to terminate the contract;
personal factors; and
intention.
Each factor is examined further below.
2.11 The contract should be the starting point when seeking to determine the status of a worker. An employee has a contract of service. A self-employed worker has a contract for services.
A contract of service essentially denotes a master-servant relationship. This indicates employment. A person is employed to work for another person.
A contract for services denotes self-employment. There is no master-servant relationship. The contract provides for the agreed services to be provided under the terms set out in the contract.
A contract does not need to be in writing. A contract may also be oral or implied. However, a valid contract must have certain elements:
the intention to enter into legal relations;
an agreement, formed by the offer of work and its acceptance; and
consideration (usually in the form of payment for the work done).
Once it has been established that a contract exists, it is necessary to consider the terms of the contract to determine the status of the worker.
However, if the written contract does not reflect the true underlying situation and agreement between the parties, the courts will disregard the contract and look to the reality of the arrangement to reach a status decision. Although written contract terms can be helpful in determining status, consideration of the contract alone is insufficient. All relevant factors must be taken into account in reaching a decision.
2.12 In deciding whether a worker is employed or self-employed it is necessary to consider whether the worker must provide his or her services personally or whether he or she can provide a replacement or substitute in his or her absence. Under a contract of services, denoting employment, the worker is required to provide his or her services personally.
The right to send a replacement, known as the right of substitution, is indicative of self-employment. If the worker has to pay the helper or substitute sent in his or her place, this would further indicate self-employment.
However, the lack of a right of substitution does not preclude a worker being self-employed. The worker may be engaged because of his or her specialist skills and it may not be possible for replacement to be sent instead.
In looking at any rights of substitution, the extent to which the engager has a right to reject any proposed substitute should also be considered. If the engager has the final say or if the worker only has the right to propose a substitute, the pointer to self-employment is weaker than if the worker has an unequivocal right to send a substitute.
2.13 For there to be a contract of services there must be minimum mutual obligations. These minimum obligations form the badges of a contract between master and servant.
As a minimum, the alleged employer must be obliged under the contract to offer continuing employment to the alleged employee.
In return, the alleged employee must be obliged to:
accept work from the alleged employer to a reasonable extent;
make himself or herself available to the alleged employer to provide his or her services; and
to refrain from looking for or taking work from another employer while tied to the alleged employer.
It should be remembered that these are the minimum mutual obligations necessary for a contract of service and usually the contract will impose further obligations on each party. Without the obligation on the part of the employer to offer work and the obligation on the part of the employee to accept work there can be no contract of service. Without a contract of service, the worker cannot be an employed earner and liable for Class 1 National Insurance contributions.
However, when looking at mutuality of obligations it is necessary to appreciate these may change over time. It may be that there is no mutuality of obligation at the start of the arrangement, but that the regular offer of work and the repeated acceptance of that work over a period of time give rise to a contract. The actions of the parties over the period are such that mutual obligations are formed.
The existence of minimum mutuality of obligations is indicative of employment.
2.14 The level of control that the engager has over the worker is relevant is determining the status of that worker. Within an employment situation, a master-servant relationship exists. For this to be the case, one party must be the master and the other the servant. This implies that where there is a contract of service (and thus the worker is employed) the engager will have more control over the worker than where the worker is engaged under a contract for services (and thus self-employed).
For example, it would be quite normal for an employee to be told when and where to work. A contract of employment would usually set out the employee's working hours. Any flexibility would generally require the employer's agreement. However, a self-employed worker would have more flexibility as to when and how he or she worked.
The fact that a worker is told how to perform the duties would point towards employment. However, the absence of such control in itself is not necessarily indicative of self-employment. Where an employee is an expert in his or her field or has a senior role it would be normal for his or her work to be unsupervised or self-managed.
However, as a general rule, the higher the degree of control that the engager has over the worker, the more likely it is that the worker is employed.
2.15 A person who is self-employed will normally provide the tools and equipment needed to perform the work which he or she has been engaged to do. By contrast, an employer will generally provide the tools and equipment needed for an employee to perform the duties of the employment.
When looking at the degree to which provision of equipment is indicative of self-employment, greater weight is given to the provision of substantial items of capital equipment. The provision of capital equipment also signifies investment in the business – another characteristic suggesting self-employment.
Many employees provide small items of equipment, such as small tools. The provision of such items does not in itself make the worker self-employed. As always, it is necessary to consider the bigger picture.
2.16 A person who is self-employed bears a higher degree of financial risk than one who is employed. A self-employed person will bear any financial risk associated with the business. He or she will correct any mistakes at his or own expense and bear the cost of jobs that overrun or exceed budget. A self-employed person will also have to meet the cost of hiring help or the cost of a replacement if he or she is personally unable to undertake the work. A self-employed person will also suffer the financial risk associated with bad debts and increasing costs.
An employee will not be exposed to financial risks of this nature.
Financial risk is a very important factor in determining the status of a worker. The risk of making a loss is taken as a very strong indicator of self-employment.
2.17 The other side of the coin to bearing financial risk is the opportunity to profit. A self-employed person enjoys the opportunity to profit when the business does well or if jobs come in ahead of budget. The self-employed person is in a position to enjoy the profits associated with good business decisions in a way that is not generally available to an employee and as such is able to enjoy the profits of his or her business.
An employee does not have the opportunity to profit in such a direct way. However, an employee on commission will earn more if he or she sells more. Likewise, an employee who performs well may receive a bonus or greater pay rise than one who performs less well and may be offered promotion opportunities. However, an employee does not suffer the losses and take the profits to the same degree as someone who is self-employed.
2.18 The length of engagement itself is not a strong indicator of employment or self-employment and must be considered as part of the overall picture.
However, the existence of an open-ended contract is likely to signify employment, although the absence of such a contract does not necessarily indicate self-employment as many employees are engaged on fixed-term contracts.
Although numerous short-term engagements may suggest self-employment, it may also be the case that the worker is a casual employee.
It is therefore necessary to consider the length of the engagement in the light of other relevant factors when determining the status of a worker.
2.19 The extent to which the worker is an integral part of the client's organisation can be a strong indicator of status.
If a worker is taken on to manage staff and is involved in making key decisions, it is highly likely that the worker will be an employee.
By contrast, if the worker is not part of the fabric of the organisation and is not regarded by the client's staff as 'one of us', it is more likely that the worker is self-employed.
Although this is an important test, it is not enough on its own to determine the status of a worker and should be considered in line with other relevant factors.
2.20 An employee will receive non-cash remuneration in addition to his or her cash salary or wages. Non-cash benefits include the right to paid holiday, pension provision and possibly items such as private health care, a company car etc.
By contrast, a self-employed worker will be paid the agreed fee for the job and will not receive any additional perks which may be given to employees. The absence of such benefits usually indicates an intention for the worker to be self-employed.
2.21 Under the terms of an employment contract, the employee can terminate the contract by giving the required notice. The employer can also terminate the contract on the giving of notice.
A contract for services does not usually include such a clause. The contract will come to an end on the completion of the task or if the contract terms are breached.
2.22 Factors personal to the worker may also need to be considered in reaching a decision as to the status of a worker. The importance of these factors may depend on the worker's level of skill or expertise.
Personal factors may be less important if the worker is unskilled and highly supervised by the engager. A high level of supervision and control over the person's work will suggest employment, regardless of the personal factors involved.
2.23 The intention of the parties can be a useful decider when the factors pointing to employment and self-employment are evenly matched. However, intention alone cannot determine status. A worker will not be self-employed, even if this is the intention of both parties, if the true nature of the relationship is one of employment.
It must be remembered that the status of the worker is a question of fact and something that can only be determined after considering all relevant factors. Employment status is not something that the worker and engager can merely agree between themselves.
2.24 The case law on employment status is extensive and the courts consider the factors set about above in reaching a decision.
Where a decision on status is made for tax purposes, that decision normally holds for National Insurance purposes and vice versa.
2.25 The case of Hall v Lorimer [1992] BTC 424 is a leading employment status case from which some important principles emerged.
Mr Lorimer was a freelance vision mixer in the television industry. He undertook work for a number of different production companies.
He did not provide his own equipment or tools and was one of many people involved in each production. He usually worked on premises owned or hired by the production company. He sometimes provided advice on the equipment that was to be used and also advised on areas relevant to his areas of expertise.
On becoming freelance, Mr Lorimer circulated his curriculum vitae to potential clients in a bid to obtain work. Most of his engagements were for a single day. The longest engagement was for a week. In the period from February 1985 to August 1989 he undertook 580 engagements.
He was free to accept or reject offers of work. He had no formal contract. He took bookings by telephone and confirmed them in writing, stating date, rate of pay, time and place.
He contributed no money to the production and did not share in profits or losses. However, he paid the expenses of running his office and his agent's fees out of his income. He also had a separate business bank account.
Mr Lorimer contended that he was self-employed. What is now HMRC contended that he was employed. Mr Lorimer won in the High Court, having won three previous tribunals. HMRC did not appeal.
The court considered the questions set out at 2.7. These failed to give a decisive answer as to Mr Lorimer's employment status. The court also took the view that the sum total of the answers to the individual questions would not necessarily give the right answer as some factors would carry more weight than others. Applying this approach, the courts found Mr Lorimer to be self-employed.
The decision had implications for labour-only subcontractors, who are not excluded from being self-employed regardless of the fact that they do not provide their own equipment. However, when seeking to demonstrate self-employment, an individual should be able to demonstrate that he or she runs a business. Factors that would suggest this include invoicing for work done, running an office at home, registering for VAT, keeping personal and business finances separate, running the risk of bad debts, promoting the business and employing staff.
2.26 The case of Dragonfly Consulting Ltd v R & C Commrs [2008] BTC 639 illustrated that a limited right to substitution in not in itself sufficient to ensure that a worker is regarded as self-employed.
The case concerned an IT contractor who provided his services to a client through an intermediary company. The issue was whether, had the contractor provided his services direct to the client, the contractor would have been an employee of the client. If this were the case the IR35 provisions (see 2.26) would bite.
The special commissioners found that, but for the intermediary company, the contractor would have been an employee of the client. The taxpayer appealed, arguing that the right of substitution within the notional contract was not compatible with employment. The appeal also considered the degree of control that the client had over the work of the contractor and the intention of the parties.
The appeal was dismissed. The court found that the taxpayer did not have an unqualified right to substitution and could only provide a substitute with the client's consent. Further, on the evidence provided, it was reasonable to conclude that the contractor's work was subject to a degree of substitution.
Whether a worker is employed or self-employed is a question of fact. The true nature of the relationship prevails over any statement of intention between the parties.
The taxpayer also sought to establish a further category, namely that of 'worker', arguing that he was a worker rather than employed or self-employed. This failed as the courts do not recognise intermediate categories of worker. A worker is either employed or self-employed. There is no halfway house.
This case was important because it destroyed the myth that including a substitution clause in a contract was sufficient to ensure that a worker was treated as self-employed (and where services were provided through a personal service company that the IR35 provisions would not bite). It illustrates the necessity to look at the overall picture and see whether the relationship that emerges is one of employment or self-employment.
2.27 There are numerous cases of relevance to employment status decisions and it is not possible to cover them all in this work.
Relevant cases include:
Argent v Minister for Social Security [1968] 1 WLR 1749 – existence of contract of services;
Ready Mixed Concrete (South East Ltd) v Minister of Pensions and National Insurance [1968] 2 QB 497 –contract of service;
Warner Holiday Ltd v Secretary of State for Social Services [1983] ICR 440 – decision on status may be made on basis of administrative convenience;
Massey v Crown Life Insurance Co [1979] ICR 590 – unimportance of labels;
Hellyer Brothers v McLeod [1986] ICR 122 – minimum mutuality obligations;
Nethermere (St Neots) Ltd v Gardiner [1984] ICR 612 – minimum mutuality obligations
Airfix Footwear Ltd v Cope [1978] ICR 1210 –minimum mutuality obligations;
Writers' Guild of Great Britain v BBC [1974] ICR 234 – contract for services;
Short v JW Henderson Ltd (1946) 62 TLR 427 – contract of service;
Horner v Hastead (HMIT) [1995] BTC 343 – over-reliance on control test;
Market Investigations Ltd v Minister for Social Security [1969] 2 QB 173 – control test should always be considered; factors to be considered in economic reality test;
Stevenson, Jordan and Harrison Ltd v MacDonald and Evans [1952] 1 TLR 101 – part and parcel of the organisation;
Cassidy v Minister of Health [1951] 2 KB 343 – part and parcel of the organisation.
2.28 HMRC publish detailed guidance on determining employment status on the employment status pages of their website. These are located at www.hmrc.gov.uk/employment-status/index.htm.
HMRC also produce factsheets on employment status aimed at both the worker and engager. Factsheet ES FSI, Employed or self-employed for tax and National Insurance purposes provides guidance for workers on their employment status. The factsheet is available to download on the HMRC website at www.hmrc.gov.uk/leaflets/es-fs1.pdf. Factsheet ES FS2, Are your workers employed or self-employed for tax and National Insurance purposes, is aimed at those taking on workers and is available to download from the HMRC website at www.hmrc.gov.uk/leaflets/es-fs2.pdf. Guidance on employment status can also be found in HMRC's Employment Status Manual (ESM), which is available on the HMRC website at www.hmrc.gov.uk/manuals/esmmanual/index.htm.
2.29 HMRC have produced an interactive tool to assist those seeking to determine the employment status of a worker. The tool, known as the employment status indicator (ESI) tool, can be accessed from the HMRC website at www.hmrc.gov.uk/calcs/esi.htm.
The ESI tool is an electronic aid which provides an opinion on the status of a worker or a group of workers by using information provided which reflects the facts of the engagement. To obtain a decision, the user must answer all the mandatory questions.
It should be noted that the tool only provides an opinion rather than a definitive or legally-binding decision.
The tool is not appropriate in all cases. It cannot be used for office holders and for workers who provide services via an agency. The tool may also fail to provide an opinion if the information is contradictory or contentious.
The limitations of the tool mean that it is probably best used to check the decision reached in relatively straightforward cases. In more complex cases, the tool may be unable to provide an opinion.
2.31 The primary legislation (SSCBA 1992, s 2(2)) provides the power for regulations to be made which categorise an earner for National Insurance purposes. The Social Security (Categorisation of Earners) Regulations 1978 (SI 1978/1689) makes various provisions with regard to categorisation of certain earners. The regulations override any decisions on status that may be reached by applying the tests set out above.
In particular, reg 2 deems the earners specified in Sch 1, Pt I to be employed earners for National Insurance purposes. This treatment applies regardless of whether such earners exhibit the characteristics normally associated with self-employment. The effect of deemed employed earner status is that the earners in question are brought by the regulations within the Class 1 National Insurance net. They will therefore be liable to Class 1 contributions rather than to Class 2 and Class 4 contributions.
The categories of earners deemed to be employed earners by the regulations are discussed at 2.32 to 2.37.
The regulations also deem certain earners to be self-employed earners. These are listed in Sch 1, Pt II. These are discussed at 2.38.
Employments listed in Sch 1, Pt III of the regulations are disregarded for National Insurance purposes. These are discussed at 2.39.
Where earners are deemed employed earners by virtue of the regulations, the associated deemed secondary contributor is specified by reg 5 and Sch 3. Schedule 3 also sets the deemed secondary contributor in other cases (see 2.40).
The regulations also provide (in reg 3 and Sch 2) that where an earner is, or is deemed to be, a self-employed earner, the earner continues to be treated as a self-employed earner until such time as the self-employment ceases. The effect of this is that the self-employed earner remains liable for Class 2 contributions for weeks when he or she is on holiday or otherwise not working as long as the self-employment has not come to an end.
Finally, the regulations make provision (in reg 4) for the procedures to be followed if a decision as to status is made by the High Court which is inconsistent with a previous direction of the Secretary of State. Broadly, the regulation gives the Secretary of State the power to treat the earner as having the status corresponding to the Class of contributions paid prior to the High Court decision for the period for which such contributions were paid if this is considered to be in the interests of the earner (see 2.44).
2.32 Office cleaners and operatives working in any similar capacity in any premises other than one used as a private dwelling house are deemed to be employed earners by virtue of the Social Security (Categorisation of Earners) Regulations 1978 (SI 1978/1689, reg 2 and Sch 1 para 1. Likewise a cleaner of telephone apparatus and associated fixtures other than in a private dwelling house is deemed to be an employed earner.
The deemed secondary contributor (by virtue of Sch 3, para 1) depends whether or not the person is supplied through an agency. Where the cleaner is supplied by or through an agency or other third party and receives his or her remuneration from or through that agency or third party, the agency or third party is deemed to be the secondary contributor. In any other case, the secondary contributor is deemed to be the person with whom the deemed employee contracted to do the work.
2.33 The regulations deem persons supplied by agencies to be employed earners where certain conditions are met. To be a deemed employed earner:
the worker must supply (or be obliged to supply) personal service;
the worker must be subject to supervision, direction or control as to the manner in which those services are supplied; and
the worker is supplied by or through a third person.
Further, the earnings for each service must be paid by or through or on the basis of accounts submitted by that third person or in accordance with arrangements with that person, or must take the form of payments by way of fees, commission or other payments of a like nature which relate to the continued employment of the person employed.
This deeming provision does not apply where the services are provided in the home of the person supplying them or on other premises not under the control or management of the person by whom the worker is employed (except where the other premises are such that due to the nature of the service, the service must be provided there).
Also excluded from this rule are persons employed as an entertainer or as a fashion, photographic or artist's model.
The person supplying the services is not deemed to be an employed earner in a case where the earnings are not paid by or through, or on the basis of accounts submitted by, that third person:
where the work has been obtained through the third person as part of that person's activities in which persons seeking employment are introduced to persons requiring their services (as in the case of a recruitment agency);
where as a result of such an introduction, the person employed and the person to whom he or she has been introduced have entered into a contract with each other for the rendering of such a service; and
where only the person employed and the person to whom he has been introduced have a direct financial interest in the worker's continued employment.
This final exclusion prevents a person recruited via a recruitment agency or a head hunting agency from being treated as an employee of the recruitment agency.
Where a deemed employment arises as a result of these provisions, the secondary contributory is the agency or other third party through whom the deemed employed earner is supplied (Sch 3, para 2).
2.34 A person is deemed to be an employed earner where that person is employed by his or her spouse or civil partner for the purposes of the spouse or civil partner's employment (or self-employment) (Sch 2, para 3).
In this situation, the spouse or civil partner is deemed to be the associated secondary contributor (Sch 3, para 3).
2.35 A person in employment as a lecturer, teacher, instructor or in any similar capacity by a person providing education is deemed to be an employed earner where the employment is one in which the person employed gives the instruction in the presence of the persons to whom the instruction is given (except where the employment is in the Open University) and where the earnings in respect of the employment are paid by or on behalf of the person providing the education (Sch 1, para 4).
The person providing the education is deemed to be the secondary contributor (Sch 3, para 6).
However, this deeming rule does not apply where the person in question has agreed, prior to giving the instruction, to give it on not more than three days in three consecutive months or if the instruction is given as public lectures.
2.36 A person employed as a minister of religion, but not in employment under a contract of services with general earnings, is deemed to be an employed earner, unless the remuneration (excluding payments in kind) does not consist wholly or mainly of stipend or salary (Sch 1, para 5). This prevents a Roman Catholic priest from being deemed an employed earner under this provision.
The associated secondary contributor is the Church Commission for England (Sch 3, para 7).
However, where the minister of religion is not employed as a minister of the Church of England or under a contract of service or where the remuneration is not wholly or mainly a stipend or salary, the relevant secondary contributor depends on the source from which the remuneration is paid.
If the remuneration is paid only from one fund, the secondary contributor is the person responsible for that fund.
If the remuneration is paid from more than one fund and remuneration from one of those funds is also paid to other ministers of religion, the secondary contributor is the person responsible for the administration of that fund. If, however, remuneration is paid from two or more funds to other ministers of religion, the secondary contributor is the person responsible for the administration of the fund from which remuneration is paid to the greatest number of ministers of religion who carry out their duties in Great Britain.
In any other case where payment is made from more than one fund, the secondary contributor is the person who carries out the administration of the fund from which the minister of religion first receives a payment of remuneration in the tax year (Sch 3, para 8).
2.37 An entertainer who is not employed under a contract of service or in an office with general earnings is deemed to be an employed earner (Sch 1, para 5A). However, this ruling does not apply where the remuneration does not include any payment by way of salary.
For these purposes, 'salary' means payments made for services rendered which are paid under a contract of services under which more than one payment is payable at a specific period or interval and where the payments are computed by reference to the amount of time for which the work has been performed.
The salary test has applied since 6 April 2003. It ensures that entertainers engaged on a single day or on two-day engagements are treated as employed earners and brings film extras and those with walk-on parts within the Class 1 National Insurance contributions net.
The associated secondary contributor is the producer of the entertainment in respect of which the payments of salary are made (Sch 3, para 10).
The case of ITV Services Ltd v Revenue and Customs Commissioners [2011] UKFTT 586 (TC) concerned the employment status for National Insurance purposes of actors engaged by ITV under a variety of contracts. The tribunal found that except for the ITV 'All Rights Agreement', all other contracts, including contracts for walk-ons, fell within the scope of the regulations as the contracts provided for the actor's remuneration to include 'payment by way of salary'. Consequently a liability to Class 1 National Insurance arises under the contracts.
Following the decision, HMRC published a Business Brief outlining the implications of the tribunal's findings (Business Brief 10/11: see www.hmrc.gov.uk/briefs/national-insurance/brief1011.htm). As a result of the decision, only actors who have entered into 'All Rights Agreements' or who are engaged for a specific production, programme or episode that does not involve payment to provide their services as and when required for a specified period of engagement are excepted from the regulations. Further, HMRC now take the view that the regulations apply to the minority of actors who had previously entered into Equity contracts on the common understanding that, as the production was dependent on them for box office success, they would remain outside the ambit of the regulations. As the tribunal decided that that there was an element of salary in these contracts and confirmed that the essential quality of salary was 'to purchase the individual's time for some definite or indefinite period, short or long, rather than to pay for specific services'. HMRC's view is that the wider implication of the decision is that this test should be applied to all actors, regardless of their status in the profession and that Class 1 National Insurance contributions will be due wherever the nature of the contract is such that it includes payment by way of salary. Consequently, HMRC have announced that they will apply the regulations to all Equity contracts that are newly entered into, revised, renewed or extended on or after 2 March 2011 (the date on which Business Brief 10/11 was published) and from 6 April 2011 to existing Equity contracts in place before that date which continue beyond the end of the 2010/11 contract and which HMRC had previously accepted as being outside the scope of the regulations.
Further guidance on the employment status of entertainers can be found in HMRC's Employment Status Manual at ESM4145 to ESM4147.
2.38 The Social Security (Categorisation of Earners) Regulations 1978 (SI 1978/1689) also deem certain earners to be self-employed earners for National Insurance purposes. Deemed self-employed earners are within the Class 2 and Class 4 National Insurance contributions net rather than within the charge to Class 1. Deemed self-employed earners are specified in Sch 1, Pt II.
The regulations (in Sch 1, para 6) deem a person responsible for the conduct or administration of any examination or professional qualification as an examiner, moderator or invigilator or in any similar capacity or in which the person concerned is engaged to set questions or tests for any such examination under a contract where the whole of the work is to be performed in less than 12 months to be a self-employed earner for National Insurance purposes.
2.39 Certain employments are disregarded for National Insurance purposes by virtue of the Social Security (Categorisation of Earners) Regulations 1978 (SI 1978/1689), reg 2 and Sch 3, Pt III. These include:
employment by a relative in a private dwelling house in which both reside other than for the purposes of any business or trade carried on there by the employer (Sch 1, para 7). For these purposes, a relative is a father, mother, grandfather, grandmother, son, daughter, grandson, granddaughter, brother, sister, half-brother or half sister;
employment by spouse or civil partner other than for the purposes of the employment of the spouse or civil partner (Sch 1, para 8);
any self-employment or deemed self-employment where the earner is not ordinarily so employed (Sch 1, para 9). This would cover the situation of, say, someone who is an employed earner and undertakes a one-off job for which he or she is paid a small fee. Such a person would not be regarded as 'ordinarily self-employed'. HMRC generally disregard self-employed income by an employed person of less than £1,300 a year;
employment for the purposes of any election or referendum authorised by Act of Parliament as a returning officer or acting returning officer, a Chief Counting Officer or counting officer or employment by any of these officers (Sch 1, para 10);
employment as a member of the naval, military or air forces of a country to which a provision of the Visiting Forces Act 1952, s 1 applies or as a civilian by any such force unless such a civilian is ordinarily resident in the UK (Sch 1, para 11); and
employment as a member of any international headquarters or defence organisation designated under the International Headquarters and Defence Organisations Act 1964, s 1, other than employment by a person who is a serving member of the regular naval, military or air forces of the Crown raised in the UK or having its depot or headquarters in the UK or of a civilian ordinarily resident in the UK who is not a member of a scheme providing a pension, lump sum, gratuity or like benefit on cessation of the employment which is established under arrangements made by the international headquarters or, as the case may be, defence organisation of which he is a member (Sch 1, para 12).
Prior to 5 July 2007, employment as a Queen's Gurkha officer or as any other member of the Brigade of Gurkhas of a person who was recruited for that brigade in Nepal was also disregarded for National Insurance purposes.
2.40 As well as specifying the associated secondary contributor in the case of earners deemed to be employed earners by virtue of Sch 1, Pt 1 of the Social Security (Categorisation of Earners) Regulations 1978 (SI 1978/1689), Sch 3 of the regulations also specify the secondary contributor in other situations.
Where a person is employed by a company that is in voluntary liquidation and which carries on business under a liquidator, the person holding the office of liquidator is deemed to be the secondary contributory (Sch 3, para 4).
The secondary contributory in respect of a person employed in chambers as a barrister's clerk is deemed to be the head of chambers (Sch 3, para 5).
Where a person is employed by a foreign employer and where, in pursuance of that employment:
the personal service of the person employed is made available to the host employer;
the personal service is rendered for the purposes of the business of the host employer; and
the personal service of the host employer began on or after 1 April 1994;
the secondary contributor is deemed to be the host employer for whom the personal service of the person employed is made available (Sch 3, para 9).
However, where the employment is as a mariner, this rule applies only if the duties of the employment are performed wholly or mainly in category A, B, C or D waters.
2.41 Anti-avoidance provisions were introduced with effect from 6 April 2000 to counter perceived avoidance of tax and National Insurance contributions where a worker provides services to an end client, via an intermediary, such as a personal service company. The provisions are generally known as 'IR35' after the Budget press release in which they were first publicised. They have attracted much criticism since their introduction and generated a wealth of case law.
The Office of Tax Simplification (OTS) was created in July 2010 to provide the Government with independent advice on simplifying the UK tax system. Their initial remit included identifying the areas that caused most day-to-day complexity and uncertainty for small businesses and specifically to explore alternatives to the IR35 legislation. The OTS published its initial findings in March 2011 ahead of the 2011 Budget, stating that while their recommended integration of tax and National Insurance contributions would render IR35 obsolete (see 1.2), in the interim the Government should consider either suspending the IR35 regime with the intention of a permanent abolition, using the period of suspension to investigate costs and behaviours or keep IR35 unchanged but change the way in which it is administered. They also proposed a third alternative – the introduction of a business test, which despite involving the introduction of new definitions and tests, it would reduce the number of people caught within the IR35 umbrella.
The Government published its response to the OTS's report on 9 May 2011. Although the Government considered all the options proposed by the OTS, they decided to retain IR35, partly due to the revenue that it raises, but with a commitment to achieve clear improvements in administration and HMRC are to be asked to undertake a thorough overhaul of the administration of this area of the tax system, with a focus on providing pre-transaction clarity and certainty and restoring trust.
The changes will include:
creating a dedicated helpline staffed by specialists;
publishing guidance on the type of cases that HMRC view as being outside the scope of IR35;
targeting compliance activity by restricting reviews to high risk cases; and
setting up an IR35 forum to monitor HMRC's new approach.
The National Insurance provisions governing IR35 are contained in the Social Security Contributions (Intermediaries) Regulations 2000 (SI 2000/727).
The regulations provide that:
where an individual (the worker) personally performs, or has an obligation personally to perform, services for another person (the client);
the performance of those services by the worker is referable to arrangements involving a third party (such as, but not limited to, a personal service company); and
the circumstances are such that were the services to be performed by the worker under a contract between the worker and the client, the worker would be an employee of the client;
the relevant payments and benefits paid to the worker are treated as earnings from the employment that are liable to Class 1 National Insurance contributions.
Essentially, the regulations consider whether, but for the presence of the intermediary, the worker would be an employed earner of the client. If this is the case, the regulations try to ensure that broadly the same amount of National Insurance contributions are payable as would be payable were the worker employed directly by the client. In determining whether, ignoring the intermediary, the worker would be an employee of a client, the tests outlined at 2.7ff should be applied.
It is the intermediary, rather than the client, who is responsible for operating the regulations.
In an IR35 scenario, the intermediary is typically a one-man company, but this does not have to be the case. However, the worker has responsibility for the control and management of intermediary. This can be contrasted with the managed service company scenario described at 2.42 where control of the intermediary lies with the scheme provider.
Under the regulations, the worker is charged to Class 1 National Insurance contributions on any attributable earnings. These are broadly the earnings that would have been earnings from the employment had the worker been directly employed by the client and on which Class 1 National Insurance contributions have not been paid. The intermediary is liable for secondary Class 1 National Insurance contributions on the attributable earnings. The calculation of attributable earnings and associated Class 1 National Insurance liability is explained at 3.15.
The rules effectively render ineffective the policy of the intermediary paying the worker dividends (which do not attract National Insurance contributions) rather than earnings in an attempt to reduce the overall National Insurance bill.
Under the rules, the worker's attributable earnings are deemed to be paid to the worker in a single payment on 5 April at the end of the tax year to which they relate. Thus attributable earnings for 2011/12are deemed to be paid to the worker on 5 April 2012.
The worker's attributable earnings are aggregated with other earnings paid to the worker in the earnings period and the earnings-related contributions due on the aggregate amount are calculated in the normal way.
2.42 Provisions were introduced for tax purposes from 6 April 2007 by the Finance Act 2007 which aimed to prevent workers from avoiding income tax by providing their services through a managed service company. Corresponding provisions have applied for National Insurance purposes since 6 August 2007. The National Insurance provisions are contained in the Social Security (Managed Service Companies) Regulations 2007 (SI 2007/2070).The regulations target the perceived use of managed service companies to avoid National Insurance contributions.
A managed service company is an intermediary company through which the services of a worker are provided to an end client. The workers are not in business on their own account (as in an IR35 case). Instead the managed service company is controlled by a scheme provider. The scheme provider is a business and generally a company which provides a generic structure and administers the managed service company.
Managed service companies are not personal service companies and are not within the IR35 rules described at 2.41. Under a managed service company arrangement, the worker obtains work via an agency. Unlike the IR35 scenario, the worker has no involvement in running the managed service company and no part in its management or control. The scheme provider organises the work between the agency and the managed service company and also arranges payment of the workers. A fee is charged for this service.
Under a managed service company scenario, the exact arrangements may vary. However a typical set up would be a composite company with between 10 and 20 unrelated worker shareholders. Each worker holds a different class of share to enable differing dividend payments to be made. The scheme provider is usually the director of the managed service company.
Alternatively, the managed service company may be a personal service company with only one worker shareholder, However, this arrangement is distinguished from a personal service company within the scope of IR35 in that control and management of the company rests with the scheme provider rather than with the worker.
The worker is usually paid a mix of dividends, salary and reimbursed expenses by the managed service company. In the absence of the anti-avoidance provisions, no National Insurance liability would arise in respect of payments made in the form of dividends.
The managed service company rules apply where:
the services of an individual are provided either directly or indirectly by a managed service company;
the worker, or an associate of the worker, receives a payment or benefit that can be reasonably taken to be in respect of the services; and
the payment or benefit is not earnings derived from the employed earner's employment with the managed service company.
Under the regulations (reg 3) the managed service company is treated as making a payment of earnings to the worker. Likewise the worker is treated as receiving earnings. The earnings are known as the workers attributable earnings. The earnings for National Insurance purposes are calculated as for tax purposes. The calculation is discussed at 3.16. The worker's attributable earnings are aggregated with other earnings paid in the earnings period and the Class 1 National Insurance liability is calculated in the usual way.
By virtue of reg 4 of the regulations, the worker is treated as an employed earner and the managed service company is treated as the secondary contributor in respect of the worker's attributable earnings. This is the case regardless of whether the managed service company fulfils the conditions prescribed for secondary contributors in SSCBA 1992, s 1(6).
Essentially the rules operate so as to treat all payments by the managed service company to the worker as payments of earnings liable to Class 1 National Insurance contributions, regardless of how the payment is described. This means that even if the payment by the managed service company to the worker is described as a dividend, it will attract a Class 1 National Insurance liability.
2.43 The issue of whether a worker has been categorised incorrectly for National Insurance purposes often only comes to light as a result of a status enquiry.
Where it is discovered that a worker has been categorised incorrectly and, as a result, has been paying the wrong Class of National Insurance contributions, the worker is brought within the correct Class of contribution.
If a categorisation decision was not sought at the outset of the working arrangement, the recategorisation will generally be retrospective so as to apply from the date on which the working relationship began. Where a person who has paid Class 2 contributions is found to be an employed earner, arrears of Class 1 contributions will be assessed. Arrears of contributions can be sought for the previous six years.
However, if the person has paid Class 1 contributions and is subsequently found to be self-employed, the usual policy is to treat the recategorisation as applying only from the date of the categorisation decision. This prevents a repayment of Class 1 contributions from being made. Although the worker is denied a refund of Class 1 contributions, this policy is regarded as being in the worker's best interest as it preserves the benefit entitlement earned in respect of the Class 1 contributions paid as a result of the incorrect categorisation. However, the worker can challenge any decision not to apply the recategorisation retrospectively.
2.44 A categorisation decision may be overturned by the courts. This can make the contribution position quite complicated.
Where a decision is made as to the categorisation of an earner, the earner is immediately treated as being liable for the class of contribution relevant to the categorisation decision. Thus if it is determined that an earner is employed he will be brought within the Class 1 net immediately. As noted at 2.43 the decision may be applied retrospectively.
An earner can appeal against a categorisation decision. If the decision is found by the court to
be incorrect the status decision will be overturned. This will return the worker to the status that he or she had prior to the status decision. However, HMRC have the discretion to prevent this revision from being applied retrospectively if this is in the earner's interests (Social Security (Categorisation of Earners) Regulations 1978 (SI 1978/1689), reg 4).
Example 2.3
A worker pays Class 2 and Class 4 contributions on the basis that he is self-employed. His status is queried and he is found to be an employed earner. He is assessed to Class 1 contributions. The earner appeals against the decision and the High Court find him to be self-employed.
During the period when the earner was treated as being employed he (and his employer) paid Class 1 contributions. This is felt to be beneficial to the worker as it offers greater benefit entitlement. Therefore the return to self-employed status is only applied from the date of the High Court decision. The Class 1 National Insurance contributions paid are not refunded.
Ensure that the status of workers is considered at the outset. Problems arise where a worker is incorrectly categorised and pays the wrong Class of contribution.
Ensure that the contract and other documentation support the reality of the situation. If the contract is a contract for services, but the reality of the situation is that the worker is an employed earner, the contract will be disregarded.
Where services are provided through a personal service company, ensure that, in the absence of the intermediary, the worker would be self-employed. Consider the pointers of self-employment, such as bearing financial risk, ability to reject work, provision of own equipment etc, and ensure that these are present.
Where possible ensure that any status decision reached can be supported by evidence.
Where employment status is in doubt, seek a decision from HMRC.
Be aware of the Categorisation of Earners Regulations and the status of workers covered by those regulations.