Every now and then, you may find that your company needs additional skills or support to successfully deliver an assignment or project. This means you may need to subcontract another business to assist you.

However, in doing so you could open yourself up to some potential tax and legal pitfalls surrounding the employment status of the engaged party – are they a subcontractor or an employee?

Usually, a subcontractor will operate as a sole trader or via a limited company. They won’t be part of your company’s payroll and the individual won’t work as an employee of your company.

What is the difference, and why is it so important?

First of all, a little bit of an explanation. Due to changes to IR35 rules introduced in April 2021 the things you need to do when hiring a freelancer or contractor will change depending on the business structure of the person you’re hiring and also the size of your business.

If you’re hiring a contractor who works through a limited company, and your company meets the official definition of a “small business” then you, as the “engager”, don’t need to worry about the employment status of the business you’re subcontracting work to – they’re simply ‘subcontractors’ in your accounts. They may have IR35 considerations if the work involved would otherwise be considered that of an employee, but it’s up to them to determine their employment status, apply the IR35 legislation and pay the correct tax.

If your company is classed as a medium or large business and you take on a limited company contractor, it’s your responsibility to make an assessment of the IR35 status and produce a status determination statement before they start on the assignment or contract. This is still the case even if you use a recruitment agency to find your contractor(s).

If you subcontract work to an individual, you’ll need to pay much closer attention to their employment status. If you incorrectly determine they’re a sole-trading independent contractor and HMRC (or the courts) deem that their work was actually that of an employee, then it’s your responsibility as the ‘engager’ to settle the unpaid PAYE and National Insurance. In addition, there may be late payment fines and other penalties for the incorrect submission of your company’s PAYE returns.

How do you determine the employment status of a worker or subcontractor?

HMRC have given some guidance on this, but it’s still a case-by-case decision and employment status cases still regularly reach the courts to decide the outcome.

Essentially, it all comes down to the definition of the contract and the working practices- is it a contract of service (employee) or a contract for services (self-employed, independent contractor)? The actual name of the contract is not important here, it is the reality of the contract and the working practices (similar to IR35).

If the answer to all the following questions is ‘Yes’, the worker is probably an employee:

• Do they have to do the work personally (i.e. they could not get a substitute to carry out the work)?
• Can someone tell them at any time what to do, where to carry out the work, or when and how to do it?
• Do they have to work a set amount of hours?
• Can someone move them from task to task?
• Are they paid a fixed amount by the hour, week, or month?
• Can they get overtime pay or bonus payments?

If the answer to all the following questions is ‘Yes’, it will usually mean that the worker is self-employed:

• Can they hire someone else to do the work or engage others at their own expense?
• Do they risk their own money?
• Do they provide the main items of equipment they need to complete the assignment, and not just the small tools that many employees provide for themselves?
• 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 and when to do the work and where to provide the services?
• Do they regularly work for a number of different clients?
• Do they have to correct unsatisfactory work in their own time and at their own expense?

Find out more about employment status’.

Whether an individual is an employee or a self-employed independent contractor not only determines how tax is applied but also relates to the various rights that employees have that contractors don’t. This is a legal definition that’s based on past and emerging case law. It’s not a definition set by HMRC – they only provide guidance.

Please note, getting this wrong can be very costly to your business both in tax/fines and legal fees.

How Crunch can help

At Crunch, our experts can help you with IR35 whether you’re a contractor, employer, or recruitment agency. Find out how Crunch can help you successfully navigate IR35 legislation at our IR35 Hub, or book a callback with our specialist advisors today.