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Employee Reward Structures by Aidan Langley & Alison HaynesAidan Langley, author of 'Employee Reward Structures' and Alison Haynes consider the significance of employment status and contrast the advantages and disadvantages of both employed and self employed status.
Employment StatusThe question of employment status is an absolutely critical one which must be determined correctly by any organisation using the skills of workers. Failure to categorise correctly the employment status of its workers can have a catastrophic impact on the financial good health of an organisation irrespective of its size or sector group.
Most businesses are heavily reliant on their workers, not only for their financial prosperity, but indeed for their very existence. For a good many businesses the costs associated with their workers comprise the largest item of annual expenditure. It is therefore very important for businesses to identify the status of their workers correctly and to ensure that where appropriate tax and national insurance contribution (NIC) costs are correctly calculated and paid. Clearly, the issue of being an employee or a self employed person is of great importance to an individual; it is no less so for the business making use of their services. Where a worker is used by a business in an employed capacity, the employer has a duty to calculate the tax and NIC due in respect of the earnings and to pay them over to HM Revenue & Customs on a timely basis. This obligation is always the employer¡¯s and failure either to identify their employees correctly, or to account for the correct amounts of tax and NIC under PAYE can be very costly for a business.
There are two main categories of employment status: employed or self employed, although further in this chapter we will also consider workers covered by the IR35 legislation, office holders and certain types of worker who are deemed to be employees for tax and/or NIC purposes.
Most issues which are dealt with in this book are described and prescribed by statute and in many instances a specific question will be answered just as specifically by statutory reference. This is not so with employment status. Certainly there are consequences of being either an employee or a self employed worker which are laid down by statute, but in general the principles determining status have been laid down over many centuries and have been primarily formulated and codified, by case law rather than statute.
Why is the distinction between being employed or self employed important?Many workers enjoy being employed earners because of the many and varied benefits associated with employment status. In particular, the security of knowing that for the duration of the contract, or until they either give notice or are given notice by their employer, they will be offered work for a certain number of hours every week or month, and in return will receive a set salary or wage, is attractive.
In addition, employees benefit from the security of knowing that they are within the remit of the employment law legislation which affords many protections to employees, including the right not to be unfairly dismissed and in most instances, the right to some form of statutory compensation or redundancy payment in the event that the business downsizes. Some employees also appreciate the fact that their employer is obligated to calculate and withhold tax and NIC under the PAYE system, ensuring that the pay they receive is net of tax and NIC costs, which relieves them of the burden of having to calculate their tax and NIC liability and of having to budget for paying such costs. Employees also benefit from paid holidays, statutory sick pay and frequently from additional benefits such as participation in an employer's pension scheme.
In contrast, self employed individuals do not generally have job security, nor do they seek it. Rather, a self employed worker will enjoy seeking out opportunities and contracts, will work for a variety of different businesses each and every year and will have the opportunity of charging for their services at the prevailing market rate, giving them the opportunity of charging rather more in good times and having to accept lower rates when prevailing market conditions dictate.
However, self employed workers are accountable to HM Revenue & Customs for their own taxes and NIC costs, they do not have the employment law benefits afforded to employees, nor do they share in any of the benefits provided by employers, such as statutory sick pay.
The taxation and NIC treatments attaching to either employment or self employment are also very different. Employees are taxable on the income they receive for acting as an employee less expenses which have been incurred wholly, exclusively and necessarily in the course of their duties [ITEPA 2003, s 336] or necessarily incurred in the case of travel expenses [ITEPA 2003, s 337]. On the other hand, a self employed worker is taxable on the gross receipts from acting as a self employed person less any expenses incurred wholly and exclusively in the course of their trade or profession [ICTA 1988, s 74]. The absence of the word ¡®necessarily¡¯ in the requirements for self employed workers means that frequently they can claim business expenses against their taxable income for acting as a self employed worker which would not be tax deductible if expended by somebody in employment.
The NIC position for employees is also different from that which applies to self employed workers. Employees are subject to Class 1 NIC, of which primary NIC is payable by the employee and secondary NIC by the employer. In contrast, self employed workers pay either Class 2, 3 or 4 NIC.
Pros and Cons of being an employed earner
Advantages/RightsFOR THE EMPLOYEE
Certainty and security including the hours to be worked and the rate of pay for the job.
Benefits provided to employee ¨C such as participation in employer's pension scheme, life insurance scheme etc.
Employment law protections.
Statutory benefits such as maternity rights.
Smooth cashflow and less administration - relevant tax and NIC will have been deducted at source.
No material business costs - tools, equipment, uniforms etc.
Ability to expect all rights granted under the contract of employment.
FOR THE EMPLOYER
Control over the way in which tasks are performed.
Certainty of resource - particularly of the number and quality of employees.
Exclusivity - particularly knowing that key workers must work exclusively for the employer and are not available to his competitors.
Ability to enforce his contractual rights and obligations from the employee.
Disadvantages/obligationsFOR THE EMPLOYEE
Less flexibility in varying or opportunity to change the terms of the contract (other than by negotiation or at annual review dates).
Pay a higher rate of NIC and have more limited capacity for taking a tax deduction for expenses against the employment income.
Must exert themselves for the advancement of their employer rather than on their own account.
Must work under the employer's direction and control.
May not leave without giving either a statutory notice period or such period as is provided for in the contract of employment.
FOR THE EMPLOYER
To provide the infrastructure and organisation of dealing with employees, including to deduct and pay over to HM Revenue & Customs the tax and NIC on behalf of each and every employee in addition to paying the secondary NIC.
To provide all relevant equipment, tools and uniforms.
To ensure that the premises on which their employees work and all equipment and tools meet all legal standards of health and safety etc to fulfil their contractual obligations to their employee, including providing the appropriate statutory notice period or such longer period as is provided for in the contract.
The additional cost of secondary NIC.
Pros and cons of being a self employed worker
Advantages/Rights:FOR THE SELF EMPLOYED WORKER
Greater flexibility and control over working, when and how they choose.
To benefit from the lower rates of NIC and more generous tax deductions for expenses of business.
To be able to react to market forces and charge more for their services when the market allows.
Not to have to perform the services themselves, but to use a substitute.
The cashflow advantage of not having to pay over their tax and social security to HM Revenue & Customs on a monthly basis.
FOR THE ENGAGER
No obligation to offer work on a regular or frequent basis - a great benefit in quiet times.
Fewer or no employment law costs, requirements or considerations.
None of the administration or infrastructure necessary for employing workers.
No requirement to withhold tax under PAYE or account for NIC.
No requirement to pay secondary NIC - in many cases this can mean a lower cost for the contract.
Reduced or eliminated need to provide employment related benefits such as sick pay, pensions or holiday pay.
Disadvantages/obligationsFOR THE WORKER
Increased risk - no job security or entitlement to redundancy pay.
No employment style benefits - sick pay, participation in employer's pension scheme.
Little or no employment law protection.
A requirement to bear costs of being in business.
A requirement to put right poor quality work at own cost.
FOR THE ENGAGER
No control over when and who undertakes tasks.
No ability to require the worker to undertake any tasks or projects.
Although outside the scope of this book, the National Minimum Wage legislation and Working Time Directive (with particular regard to the rights of workers to have paid holidays each year) should be considered as the term 'workers' for the purpose of these pieces of legislation can in certain circumstances include self employed workers.
About Employee Reward StructuresThe above article is adapted from 'Employee Reward Structures', published by Spiramus Press Ltd. For further information and to order a copy of this title, click here.
About the authorsAidan Langley, has practised as a solicitor and now works for a Big Four accounting firm, advising smaller companies on the design and implementation of short and long-term reward plans.
Alison Haynes, author of the section on employment status, is a partner in the Employer Solutions group at Deloitte & Touche LLP, advising on employment tax matters.
About The Author
Mark McLaughlin is TaxationWeb's Co-Founder, Director and Technical Editor. He is a Fellow of the Chartered Institute of Taxation and a member of the Association of Taxation Technicians and the Society of Trust and Estate Practitioners. He lectures on tax subjects, is co-author of Tottel's IHT Annual and Ray & McLaughlin's IHT Planning, and Editor of Tottel's Tax Planning and Annual series. Mark's work has also been published in Taxation, Tax Adviser, Tolley's Practical Tax, Tax Journal and Simon's Weekly Tax Intelligence.
Since January 1998, Mark has been a consultant in his own tax practice, Mark McLaughlin Associates, which provides tax consultancy and support services to professional firms. He publishes a regular 'Tax Update' e-Newsletter for clients and other professional firms. To receive future copies, contact Mark via his website.
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