Employed or Self Employed – employment status review

Construction companies paying self-employed operatives in-house often ask the question, what happens if we receive an employment status review and HMRC finds that we have incorrectly treated a worker as self-employed instead of an employee? In short, HMRC will recover PAYE and NIC that should have been deducted from the earnings.

Initially, HMRC will try to reach agreement with the employer and collect PAYE and National Insurance via a contract settlement. Once the amounts paid to the employee are agreed, HMRC will calculate the PAYE and NIC due for each year, together with the interest due on the late payments and then determine the amount of penalties due. If the employer agrees with the total due, HMRC will invite the employer to enter into a contract settlement where the employer agrees to pay the amounts due in return for no further action being taken.

If the employee has declared the income as self-employment on his tax returns and settled liability via self-assessment, HMRC can agree to offset the tax paid by the employee against the PAYE payable by the employer by making a direction under Section 72F Income Tax (PAYE) Regulations 2003, provided the employee agrees. A direction does not involve the employee paying additional tax, it merely allows the employer to claim a tax credit for the tax already paid, while preventing the employee from reclaiming the tax back. If no direction is made, the employee could amend his tax returns and reclaim the tax paid under self-employment as he will receive a credit for the tax paid by the employer on the reclassified income.

It should be possible to get relief for the class 2 and 4 National Insurances against the employee’s National Insurance liability but not against the secondary employer’s NIC.  Given the employee’s liability will almost always exceed the combined class 2 and 4, this is never really in point.  The relief can be given provided the self-employed individual has made payment to HMRC of the class 2 and 4 amounts prior to the status decision having been reached.

It is worth noting that any penalty levied as a result of the status decision will be levied on the pre-setoff amounts.

If agreement cannot be reached on either the status of the worker or the amounts due, HMRC can raise a determination on the employer for the amounts they deem payable. This is called a regulation 80 determination. A similar determination under the Social Security Contributions Act can be made for the NICs determined. In both cases, warning letters will be issued so that representations can be made.

The period over which HMRC can seek recovery of PAYE is determined by the Finance Act 2008 and depends on the nature of the error. The normal time limit is 4 years from the end of the tax year in which the PAYE is due but can be extended to 6 or 20 years depending on whether the error is careless or deliberate. If PAYE was due for 2017/18, HMRC would have until 5 April 2022 to bring PAYE into charge.

Where the liabilities arise out of deliberate or careless errors, the penalties will range from 15% to 100% of the liability depending on the nature and quality of the disclosure.

Example

X Construction Ltd engaged Joe for the past 5 years as a self-employed ground worker.  After a PAYE audit, HMRC have established that Joe is actually an employee and should have been classed as such from the outset.  The error is deemed as careless and HMRC will pursue for the full period.

For the current tax year, X Construction Ltd will need to reclassify all payments to Joe as earnings and calculate the PAYE and NIC accordingly.

Year Earnings PAYE Due Employee’s NIC Employer’s NIC Total Self-Assessment
2019/20
30,000
3,500
2,950
2,565
2,565
3,000
2018/19
30,000
3,500
2,950
2,565
2,565
3,000
2017/18
30,000
3,500
2,950
2,565
2,565
3,000
2016/17
30,000
3,500
2,950
2,565
2,565
3,000

Joe will need to be added to the payroll for 2020/21 and the PAYE and NIC due on the monthly earnings added to the next remittance.

If a contract settlement is agreed with HMRC, the amounts payable by X Construction Ltd will be as follows.

PAYE for 2016/17 to 2019/20
14,000
Less Paid by Self-Assessment by Joe (after CIS credits)
12,000
2,000
NIC for 2016/17 to 2019/20
22,060
Interest – say
3,000
Penalties – say
3,000
Total Payable
30,60

The example is for illustrative purposes only but gives a realistic indication of a liability in the region of £30,000 on one operative for a 4-year period. Now consider how this can escalate for an entire workforce.

Speak to The Guild for a review of your engagement procedures and how we can remove your exposure to a reclassification of your self-employed workforce to PAYE and an enquiry which could severely damage your business.

If you would like to raise anything we’ve discussed in this article, please call us on 020 8515 2975 or email us at info@guildhubservice.co.uk and talk to our expert team. We’re here to help.

GuildHUB is an information resource, provided free of charge by The Guild, for accounting professionals and their clients.  If you wish to contact The Guild, please email contact@trusttheguild.com.

The content of this article is for guidance only and shall not constitute advice. Please seek independent advice or contact GuildHUB for information about its services.

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