Employed and Self-Employed Tax Implications

Subject: Economics
Type: Analytical Essay
Pages: 4
Word count: 1237
Topics: Tax, Entrepreneurship, Macroeconomics
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Introduction

The status of an individual as employed or self-employed has significant implications on matters of taxation. These implications concern both the individual and the employer, in the case of the employee, due to the determination of the allocation of income taxes. Therefore, it is important that a particular range of characteristics be applied to determine the status of individuals. The differentiation is unclear under UK employment law, leaving the distinction to individual situations and given checklists. This paper analyzes the characteristics that differentiate these statuses, as well as the implications that they have on the taxation policy.

Factors for Consideration

In the typical effort to determine if the individual is an employee or is self-employed, the beginning step is consideration for the details of the contractual agreement existing between them and the engager (James, 2016, p. 38). The expectation is that their contract elaborates the capacity of the employee or otherwise. Notably, however, the employee or self-employed person and the employer (for the employee) will usually be in unequal bargaining positions (James, 2016). It is this inequality that prompts the application of additional measures as a basis for determining the positions of the individuals relative to the engager. At the same time, Section 230(1) of Employment Rights Act 1996 provides the definition of an employee as a person entering into work under an employment contract (Employee Rights Act, 1996). Nevertheless, the regulation fails to adequately interpret this contract of employment to a degree to which it would be a basis for differentiation between the employee and a person engaging the other in a self-employment capacity (Lexis Nexis, 2017). 

One of the critical factors is the nature of service. The employee will only provide personal services while the self-employed person may offer personal services and also contract some of them to others (Evans, 2016). This initial perspective leads to the second factor, which is the degree of obligation, or the mutuality of obligation (Freeman, 2001, p. 60). The employee is obliged to work as the employer requires. However, the self-employed individual may decline the requirement to work in situations when they do not wish to provide the services. In O’Kelly and Others v Trusthouse Forte Plc., the absence of mutuality of obligation and lack of clear intention to form an employment relationship dismisses the possibility of the capacity as an employee (O’Kelly and Others v Trusthouse, 1983). This latter perspective also implies that the self-employed person also demonstrates significant control over the work they perform (Lymer & Oats, 2012). There is some degree of controversy that may emerge in the case of high-skill situations for employees. Some employees may possess such notable skill in the area of work that their control over the manner and time of performance is notable (Freeman, 2001). However, this controversy is eliminated that the control only extends as far as the employer can allow. 

Additional determinants include the risk, equipment, and length of engagement. For the self-employed person, their profit is often dependent on the risks they incur in the course of business. For this reason, the person may report their expected payment for the job on individual basis as opposed to expecting a comprehensive payment as income (Lexis Nexis, 2017). This aspect is contrary to the employee, who rarely personalizes risk during work except in situations where compensation is on commission or they have amounts coming from bonuses (Rossmartin, 2017). Employees also typically use equipment from their employer, while the self-employed tend to bring their own equipment (Rossmartin, 2017). This characteristic, however, may not be universal as there are employees with preferences for personalized tools and contractors that use equipment from the engager. At the same time, self-employment typically lasts shorter periods than employment (Rossmartin, 2017). These factors work as a combination of shopping lists that may be applied in multiple contexts. However, it is imperative that their application be critical due to the subtle variations characteristic of the modern context of work. The barriers in factors may be blurred to a significant degree, requiring multiple perspectives before the ultimate determination of the nature of engagement. 

Tax Impact

The distinction between employees and self-employed individuals has significant implications on the obligation and payment of taxes. Here, the employee is considered to be working under the contract of service while a self-employed person works under a contract for services (Freeman, 2001). 

The employer bears the obligation for PAYE and accounting tax on behalf of the employee (Lymer & Oats, 2012). However, the self-employed individual pays direct tax on their income. It is important to note that this distinction tends to bear most significance for the employer. The employer has the obligation to operate PAYE on each employee, which will usually manifest as an expense on their part (James, 2016). Considering the profit aims and the income expense’s influence on the operational costs, it is favorable when majority of the operations are not among employees. Therefore, where individuals working for the organization are not classified as employees, the organization can afford to avoid the unnecessary tax (Lexis Nexis, 2017).

The preference for employers to have service providers classified as self-employed, such as in the case of independent contractors, suggests that the same level of interest exists on the part of the individual. When the status of the person is that of self-employed, they must file their taxation for their income (Blanchflower & Shadforth, 2014). At the same time, they may have to register to file for their own VAT in addition to the efforts to file their income tax (Blanchflower & Shadforth, 2014). However, this VAT requirement is subject to conditions in the operational environment such as the threshold provided by the HMRC annually. Where the turnover from the business engagements is above this given threshold, then the person encounters additional expenses in the form of VAT (Lexis Nexis, 2017). 

There has been massive debate regarding the fairness of this approach, especially with the transformation in the nature of work in contemporary businesses. Many people are working in non-employee capacities due to either the part time contracts or other arrangements with similar characteristics (Freeman, 2001). These individuals may provide the same quantity and quality of work as those considered employees due to their contracts, but the treatment for taxation differs (James, 2016). The perception has been that this is unfair and formed the basis for extensive efforts of tax reform beginning the turn of the century. Nevertheless, due to horizontal equity being only one of the bases determining the comparability and determination of these work statuses, the provisions of the tax law remain largely consistent today (Lymer & Oats, 2012).   

Conclusion

It is evident that the determination of the status of a worker is subject to multiple factors, most of which may not be within their control. The nature of their engagement with the other entity in question is the ultimate determinant of this status. Multiple tests are available for the determination of the status, including testing for control, mutual obligation, and a shopping list that includes equipment and risks. Depending on the outcomes of this checklist, the position as en employee or self-employed has significant tax implications. The employee has their tax obligation covered by the employer PAYE, while the self-employed individual should file their income tax. Even while their incomes may be similar, the self-employed person ultimately bears a greater burden in the form of taxation than those with classification as employees. 

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  1. Blanchflower, D. G. & Shadforth, C., 2014. Entrepreneurship in the UK. London: Now Publishers Inc. Employee Rights Act 1996
  2. Evans, G., 2016. Employed vs. self-employed: determining worker status. [Online] 
  3. Freeman, J., 2001. Employed or self-employed? Tax classification of workers and the changing labour market, London: Tax Law Review Commitee.
  4. James, M., 2016. The UK Tax System: An introduction. 1st ed. s.l.:Spiramus Press Ltd.
  5. Lexis Nexis, 2017. Tax implications of employment status—overview. [Online] 
  6. Lymer, A. & Oats, L., 2012. Taxation: Policy and Practice. s.l.:Fiscal Publications. O’Kelly v Trusthouse Forte Plc. [1983] ICR 728
  7. Rossmartin, 2017. Employment status checklist. [Online]
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