There are more than 1.5 million freelance contractors and consultants in the UK. Most are genuine and pay tax in full. Indeed, many would rather be on the payroll and taxed through PAYE, but aren't given the choice by employers, some of whom are abusing the tax system. But other freelances are, to put it bluntly, on the fiddle.
A committee of MPs, led by Margaret Hodge, have expressed their shock and disgust at how many of the BBC's high-earning stars are paid through "personal service companies". By channelling their earnings through a personal service company an individual is paid gross and can cut their tax to around 20%, especially by avoiding national insurance.
The revelations led to an orgy of BBC-bashing – the corporation admitted to 25,000 off-payroll contracts, allegedly including some of its biggest stars, but the issue runs far wider. Across Britain, employees paying full tax through PAYE can for years be sitting next to individuals classified as contractors and freelances, who pay far less. Typical is this online comment from a reader of the Telegraph's coverage on the story: "I work with a contract worker going to the same office as me for over 20 years. He can claim his rail fares to from work and other perks. It's not fair [to those of us] on PAYE."
The official term used by HM Revenue & Customs (HMRC) is a "disguised employee", which describes individuals who are directly employed by a company, but cheat the tax system by claiming they are a freelance or contract worker. But many would argue that the "cheat" is as likely to be the employer as the individual. Employers use outsourcing and casualising of their workforce to save on national insurance, pensions, holiday pay, and above all to skirt employment law. In general, employees have rights – especially regarding dismissal – that casuals and contractors don't. Indeed, some employers insist that individuals structure themselves into a personal service company so they don't have to pay national insurance and can fire them at will.
HMRC has long tried to weed out disguised employees. The law already states that employees cannot resign and start work again in their previous job employed as a company. As long ago as 1999, then chancellor Gordon Brown ordered a clampdown on disguised employees through what became known as "IR35". It set out a number of tests designed to catch companies and individuals avoiding tax.
So how can you spot a disguised employee? It's not only about the length of engagement; a contractor can, legally, remain with one company for years. HMRC looks at a number of tests. Broadly speaking, if someone behaves like an employee and is treated like an employee, they probably are an employee, and can't be paid gross. HMRC couches it in terms such as "control" and "substitution".
• Control Does the employer have control over the individual, deciding when and where they work? Can the employer move the individual to a variety of tasks? Does the employer require the individual to work the same hours as other workers? Does the employer decide which part of a project the individual will carry out? Does the individual have to request when they can take time off? Is he or she expected to "busy themselves" when work on a particular project dries up? If the answer to any of these questions is yes, it's likely the individual is an employee, not a freelance or contractor.
• Substitution If the individual can't substitute someone else to do their work, they may be regarded as an employee. This is where some high-profile figures in the media may find the rules challenging. They can set up a company that provides services, but if the TV or radio station won't accept anyone but them HMRC may argue they are, in fact, an employee.
• Right of refusal This is crucial. In an employee/employer relationship, there is something called "mutuality of obligation". If a contractor can't prove they have the right to refuse work, it suggests they are an employee.
• Business premises Does the individual own or rent business premises separate from their home and from where they are contracted to work?
• Efficiency Can the individual finish a contract early? Can they, for example, agree a £10,000 fee for three months work and finish it in two? If so, they are a contractor. If they are expected to do something else for that other month, they are probably an employee.
• Assistance Does the individual engage other workers who bring in at least 25% of turnover? Then the "personal service company" would, in the eyes of the HMRC, appear genuine.
• Advertising Has the individual spent at least £1,200 in the past 12 months on advertising? This is evidence they are a genuine small business seeking work.
These tests are designed to catch people who behave like employees, but get paid by a limited company. In the last budget the tests were tightened further, with a package of measures to "tackle avoidance through use of personal service companies".
Yet IR35 has, in reality, only had limited impact on the growth of personal service companies. It was expected to raise around £300m a year in lost national insurance and income tax from disguised employees, but a September 2011 freedom of information request revealed that figure was less than £2m. The Professional Contractors Group, established in protest against IR35, has fought thousands of battles on behalf of freelances against HMRC – and won nearly all. It published figures in 2010 revealing that its legal advisers had won 1,485 cases for members, while HMRC won just eight.
Meanwhile. HMRC has lost its appetite for IR35 challenges. In 2003 it carried out 1,000 "enforcements" of the legislation; that fell to just 23 last year.
John Brazier, managing director of PCG, says: "The solution is not to outlaw freelancing wholesale within the public sector. The jobs market is changing, not just here but across Europe. The government, rather than taking the retrograde step of attempting to push back against that change simply because it causes a few taxation difficulties, must develop a more sophisticated tax policy that changes with it."
