Foreword

This report forms the first part of the OTSs review into employment
status. It presents the facts and evidence found as a result of a
detailed study into the current problems faced, a range of possible
solutions to solve and limit these problems as well as potential
implications the review may have on the overall business environment.
The report shall summarise key areas of difficulty that have been
identified through this fact-finding exercise, and suggests certain
industries and priority areas of complexity that require further
attention.
Changing work patterns have led to an increasingly complex business
world and this has led to some ambiguity for both employers and
workers alike in regard to their specific employment status.
As declared by Vince Cable when the review was announced in July
20141 , this report aims to examine the dividing line between
employment and self-employment in order to determine whether it is
drawn in the right place and in the right way. Additionally this review is
to identify particular areas of difficulty relating to employment status
arrangements and to make suggestions and recommendations to
simplify such legislation and provide more certainty to individuals and
businesses.

Calum Morgan
Chairman, Office of Tax Simplification

Current System & Problems Identified

Upon initially considering the present state of the current system, a
review and summary of past OTS studies was carried out. The
distinction between the employed and self-employed was highlighted
as a major issue and source of complexity in the previously published
tax reliefs review2 and the small business review3. In the latter, the

OTS stated that it is vitally important for the tax system to fit with the
real world but in many instances case law is too difficult to apply for
both large and small businesses alike. Offering a higher level of
certainty to individuals and businesses is therefore necessary.
Consequently, the main driving force behind this review was this
uncertainty underpinning the current employment status
determination as well as other criticisms towards the system in place.
Changing working patterns and the emergence of unique types of
employments have caused uncertainty as to whether some individuals
should be classified as employed or self-employed for tax related
matters. Increasing the complexity and confusion a third category,
driven by European Union directives, entitled worker has been
introduced into employment law. Strictly speaking workers may
divulge in aspects of both employment and self-employment but are
entitled to fewer employment rights than individuals
As a result of the disparity and differing rules for the payment of taxes
between employed and self-employed individuals, this matter is seen
as an issue of strict importance for both working individuals and HM
Revenue and Customs. Although in the vast majority of cases it is
rather clear whether an individual is self-employed or employed the
increasing prominence of unique employment methods such as zerohour contracts and freelancing and agency work have led to some
cases where it is more difficult to distinguish. The current test to
determine employment status concerns the nature of the contract
between the working individual and the person who is paying for this
work to be done. If the contract entered into is defined as a contract of
service then the taxpayer shall be regarded as an employee who
provides their services to an employer. If, however, the contract can be
defined as a contract for service then the individual shall be deemed
as self-employed who renders their services to a client.
A large amount of case law has been undertaken on this subject to
determine the exact definition and characteristics of each type of
contract. When determining whether a contract of service exist, a
number of factors must be considered. It should be noted however that
these tests are not fully comprehensive and as such do not offer
complete certainty. Instead,, each of the terms and conditions of a
contract must be considered independently and then balanced against
the other conditions which exist to determine an individuals
employment status. As per HMRC4, the commonly applied set of
criteria to determine between contract of service and a contract for
services is as follows:
Control

Equipment

The more control exercised over a

worker the more likely it is that the
worker is an employee, regardless of
what the contract says.
Employees do not generally provide
their own equipment whereas selfemployed individuals do

Holidays & Sickness

Work Performance

Remuneration

Exclusivity

Employees receive a regular wage or

salary whereas self-employed receive
separate fees for each job and income
is often dependent on the success of
the business.
Self-employed individuals often
delegate their work to staff or
subcontracts whilst employees are
expected to carry out their work
themselves
Employees receive a regular wage or
salary whereas self-employed receive
separate fees for each job and income
is often dependent on the success of
the business.
an employed person employment is
usually exclusive to one specific
employer whilst under contract
whereas self-employed people
typically have a number of different
clients with no general exclusivity

Exhibit 1.1 Criteria for employment assessment

Currently, many individuals cannot be certain what their employment
status is until they appear at an employment tribunal, for example, if
they are seeking a claim for unfair dismissal. If they are merely a
worker, at this point they could realise they do not have any legal
protection. In order to prevent this the government wish to put a
process in place in which both the individual and the employer are
clear at the time of recruitment which rights are available. This also
aims to discourage workers from taking issues to tribunals and provide
more transparency and discussion of relevant employment concerns.
The confusion surrounding employment status should also be
recognised as an important issue due to the differences in tax and
national insurance contributions between the employed and the selfemployed. Under current tax law, self-employed individuals can take
advantage of significant tax benefits and pay less in National Insurance
Contributions (NIC) compared to taxpayers classified as employed. The
current treatments for both statuses can be seen in Exhibit 1.2 below
but relatively speaking, the self-employed are responsible for paying
their own tax and National Insurance through self-assessment whereas
employees pay tax and National Insurance via their employer through
PAYE. Some have argued that this creates an unfair benefit to selfemployed taxpayers and indeed, this is an issue that the OTS should
consider. Due to these favourable tax and NI benefits, individuals in
questionable cases the taxpayer will ordinarily wish to claim selfemployed status whilst HM Revenue and customs will often insist that
the taxpayer is treated as an employee.
Exhibit 1.2 Current tax treatments

Employed
taxed at source on earnings
under the Pay As You Earn
scheme
National
insurance
contributions
(NICs)
deducted at source
Employers NICs paid by
employer
into
the
NI
scheme (12.8%)

Self-employed
responsible for accounting to HMRC for
own income tax and NI contributions
Needs to account to HMRC for VAT, if
earnings have reached/exceeded the
required level

Sectors of Interest
The presence of these tax benefits for the self-employed has led to a
possibility of exploitation known false self-employment. In addition to
tax evasion incentives, businesses may be attracted to such schemes
in order to avoid having to respect employment rights and
entitlements such as holiday pay, sick pay and pensions which selfemployed individuals are not entitled to. As Paul Johnson, Director of
the Institute for Fiscal Studies, told MPs in 2007, The current way of
treating the self-employed for National Insurance is a huge open
invitation to tax avoidance, because it is so much lower than you pay
as an employee. Therefore, there is a very large incentive to be selfemployed or to claim you are self-employed.5 The construction
industry is perhaps the sector in which this false self-employment is
most prominent. In fact, The Union of Construction, Allied Trades and
Technicians (UCATT) estimate that over 50% of people working within
the industry are falsely self employed6. The Construction Industry
Scheme (CIS) has come under fierce criticism for legally allowing such
practices however, as per the terms of reference, this scheme shall not
be discussed within this review and is perhaps something for the OTS
to investigate further in the future.

At first glance, such tax avoidance incentives may be seen as the main
reason behind the prominence of ambiguous employment styles such
as zero-hour contracts and agency workers. However, Dave Chaplin,
CEO of Contractor Calculator states his belief that the increasing
popularity of such types of employment has occurred for reasons that
are not grounded in taxation but are instead driven by simple
business decisions7. It is recognisable that many businesses require the
labour of highly skilled workers and the use of flexible workers would
enable them to gain such labour at a cost-effective price. Such an
individual is only employed for as long as is necessary and does
therefore not take up a permanent contract of employment. This can
create a problem for the payment of taxation as it is not entirely clear
which employment status this flexible worker falls under.
As has been stated in previous OTS studies, a huge grey area exists in
between the states of employment and self-employment. In practical

terms, there is a continuum from employment to self-employment.

Some employees work on projects and may appear to operate
autonomously but their contract says they are employed. Likewise,
there are contractors who may work solely with the same client for
years, yet their contract says they are self-employed. The increasing
use of personal service companies, for example I.T. services, and
agency workers highlight further trends in employment that exist
within the grey area. An interesting and somewhat relevant case
from the distant past relates to the musicians on board the ill-fated
maiden voyage of HMS Titanic8. Instead of being hired by the shipping
line as members of the crew, the band members were instead hired as
independent contractors. This meant they were not covered by the
British Workers Compensation Act and ultimately their families were
not entitled to any compensation as a result of their deaths, unlike
those of registered crew members. Although not entirely relevant to
todays laws and regulations, the case highlights that ambiguity behind
such working arrangements has existed in the past and may well
continue into the future.

Potential Solutions & Implication of Review

As a result of the tax advantages available, Truman9 identifies a 2.4
billion subsidy from the employed to the self-employed in regards to
national insurance payments. A 2013 report by CentreForum10 argues
that money raised from levying higher national insurance rates on selfemployment income could be used to give employed workers a 110
tax break. This would effectively reduce the subsidy identified by
Truman, creating a more even playing field between the employed and
self-employed whilst also eliminating the need to distinguish between
employed and self-employed for tax reasons. The report further
proposes the ideas of scrapping of Class 2 National Insurance and
increasing the point at which NICs are payable. These steps, it
conclude concludes would mean the poorer 50% of self-employed
workers would also be better off or remain unaffected, despite the
overall rise in rates.
Another suggested measure is the possibility of merging Income Tax
and National Insurance contributions, an approach investigated by
Loutzenhiser and Adam (2007)11 in a report for the Institute of Fiscal
Studies. It is argued that Income Tax and NIC have converged over the
years to the point that they are very similar taxes. However the
combination of the differing rates and bases can make the combined
effect rather obscure and possibly misleading. For example, Labour
promised no increase on Income Tax in their manifesto for the 2001
general election but made no mention of national Insurance. Upon
taking power NIC rates were increased meaning the party effectively
kept their promise albeit in rather dishonest circumstances. As a result,
it is proposed that integrating Income Tax and National Insurance
would therefore make the overall rate of income taxes clearer and
provide a more understandable system for the average working
individual.

Whenever producing such a report, it is important that the implications

of doing so are fully recognised and whilst the government see the
review as a necessary analysis, others are not so approving. Martin
Hesketh, for example, is managing director of accountancy
firm Brookson and writes that members of the flexible workforce may
be affected negatively by any potential changes suggested in the
review12. He argues that having played such a pivotal role in the
economic upturn of the country, they must now be given continual
support and a period of legislative stability to continue the recovery
Although not in included in the terms of references, the implications of
the review on IR35 regulation should also be considered. Many experts
on the anti-avoidance legislation are against the review13 with status
advisory firm Qdos warning Any recommendations that OTS makes to
improve the tests of employment/self-employment are bound to have
a knock-on effect for IR35. It is therefore imperative that any new
legislation or approach introduced by the review will be applied via
IR35 in the same way the current law is.

Concluding Remarks
Current employment status is fraught with uncertainties and it is clear
that definitive action must be taken to with to ensure an effective tax
system is in place.
Under the current status, employment and self-employment are two
extremes of a continuum, and the huge grey area in between each
extreme only serves to bring confusion and the possibility for
exploitation. It is clear that for any efficient tax system certainty is
present for employers, employees, the self-employed and those
ensuring the rules and regulations are enforced. For as long as the
current disparity of tax and NI contributions between the employed
and self-employed exists, a significant effort must be made to ensure
taxpayers are provided with this certainty. As such the OTS must work
to ensure that clarity is provided and a more defined dividing line is
created and expressed in simple terms. In order to do so an
introduction of simple employment status tests should be carried
out. These tests would ideally reflect the principles of employment
rather than a rigorous assessment of every minute detail.

Furthermore, it could be argued that a concentrated effort is required

to bridge this disparity gap which will, in turn, effectively render the
employment vs self-employment argument irrelevant. The creation of a
more equal playing field between both employment states could prove
the vital step in not only ensuring legislation is fairer but also more
certain and easy to understand. Additionally, the possibility of
integrating Income Tax and NIC should also be recommended in order
to offer increased transparency and reduced administrative and
compliance costs.

References
1 - http://www.gov.uk/government/news/employment-review-launchedto-improve-clarity-and-status-of-british-workforce
2 - https://www.gov.uk/government/publications/tax-reliefs-review
3 - https://www.gov.uk/government/publications/small-business-taxreview
4- http://www.hmrc.gov.uk/manuals/esmmanual/index.htm
5- Oral evidence to Work and Pensions Committee, Single-tier State
Pension report, www.
publications.parliament.uk/pa/cm201213/cmselect/
cmworpen/1000/130227.htm
6 - http://www.ucatt.org.uk/false-self-employment
7http://www.contractorcalculator.co.uk/ots_employment_status_review_4
85610_news.aspx
8 - http://blog.reduceyourworkerscomp.com/2012/04/bands-of-the-rmstitanic-a-workers-comp-tragedy/
9 - http://www.taxation.co.uk/taxation/Articles/2014/09/09/330551/i-mdreamer
10 http://cminteractive.net/ci/centreforum/reagling/menttaxbreakPresscop
y1.pdf
11- Adam, S. and G. Loutzenhiser (2007), Integrating Income Tax and
National Insurance: An interim report, IFS Working Papers W07/21,
December.
12
-http://www.contractoruk.com/news/0011668why_otss_employment_st
atus_review_isnt_ideal.html
13http://www.contractoruk.com/news/0011666ots_employment_status_re
view_bound_have_knock_effect_ir35.html