When is a subcontractor really an employee?

We're big advocates of outsourcing to grow your business. But there are limits to how much work you can outsource to one person before HMRC considers them your employee and expects you to pay their tax and National Insurance. Emily Coltman, lead accountant at FreeAgent, takes a look at the difference between subcontractors and employees.

As is often said at Enterprise Nation, "Do what you do best, and outsource the rest!" If you're running a small business, you may well decide to outsource certain services, such as phone answering, or building and maintaining your website. If you choose to outsource to a one-man or one-woman business, how do you know whether HMRC might consider that person is actually employed by you? And, indeed, if you are providing services to clients, is there a risk that HMRC might think they're employing you?

What does it matter anyway?

HMRC get more money through the employer-employee relationship because there's no employer's National Insurance to pay on subcontractors' fees, unlike on employees' wages. HMRC look through any contracts (a contract of service for an employee, a contract for services for a subcontractor) and examine the actual dynamic of the relationship between the two parties - and if they find it to be really an employer-employee relationship, they'll ask for more money. If the quasi-employee is a sole trader, then it'll be the client who pays that extra.  But if the quasi-employee trades through an intermediary (their own limited company, or partnership), it's that intermediary that's liable for the extra. So it could be very important!

When might HMRC consider someone is really an employee?

They will look at the whole picture and consider the relationship between the parties. In an employment situation, the relationship will be on a "master-servant" level, rather than a relationship of two equals.

What does a "master-servant" relationship actually mean?

There's no statutory definition of when someone will be an employee, but HMRC give a series of questions as a general guide to help establish the picture. Here's a summary of what HMRC are looking for:

• Employees have to do the work themselves; subcontractors can hire someone else to do the work at their own expense.

• Employers tell their employees what to do, and where, when and how to do it, and move them from task to task.  Subcontractors can decide this for themselves.

• Employees work a set number of hours; subcontractors only carry out work when they're needed.

• Employers are obliged to provide their employees with work, but there's no such obligation if the worker is a subcontractor.

• Employees are paid by the hour, week, month or year.  Subcontractors are often paid a set fee for a job, regardless of how long it takes to do.

• Employees may receive overtime pay, bonus payments, holiday pay and sick pay.  Subcontractors are very unlikely to be given any of these.

• Employees don't risk their own money in a business.  Subcontractors do, but they can also derive a reward by making profit on a particular job. For example, a self-employed printer gets to keep more of his earnings if he can buy paper more cheaply.

• Employees don't have to correct any errors they make in their own time and at their own expense, but subcontractors would have to do this.

• Subcontractors often work regularly for a number of different people.

• Employers will provide equipment such as computers for their employees, but subcontractors will often provide their own equipment.

These are not hard and fast rules, though.  For example, if an employee is hired because they are expert in their particular field, the employer may not exercise as much control as over a trainee employee. In some businesses, such as accountancy offices, subcontract staff often work alongside employees and are expected to use the internal computer systems rather than bringing in their own laptops. HMRC will also look at whether a particular individual is "part and parcel" of the organisation.  An email address at the organisation, business cards, and the individual describing themselves as part of the organisation, for example "I'm Emily Coltman from FreeAgent", is a pointer to employment. A particular person may be employed in one role but self-employed in another. For example, I have a full-time job with FreeAgent where I am an employee. I also do screencasting work in my own time and that's a self-employment.

The whole picture

HMRC do look at the whole picture rather than considering any of these factors in isolation - and having a contract for services in place rather than a contract of service is not enough on its own to point to self-employment.  They look at the substance of the relationship. So if you are either self-employed or employed by your own limited company yourself, or plan to outsource part of your business to someone who might be a quasi-employee, be careful!

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Photo credit: Lauren Powell-Smothers