Type “misclassification” into your search engine and, even here in the UK, the results are dominated by US Web pages denouncing the practice of wrongly classifying employees as independent contractors. However, as I outlined last month, misclassification of employees is not an issue confined to the US. Many countries are witnessing an increase in the numbers of individuals providing personal services, either in a self-employed capacity, or incorporating as a small business.
In most jurisdictions, the test to determine the employment status of an individual providing personal services on a contingent basis is whether the person to whom the services are provided has the right to control the work of the service provider.
The “control” tests tend to look at whether the employer has the authority to direct the worker in what, when, how and where the work is performed. This test is formulated from the common law relationship of “master” and “servant,” and in the UK was recognized by the courts as far back as 1880, in the case of Yewens v. Noakes, when Lord Justice Bramwell said that “a servant is a person who is subject to the command of his master as to the manner in which he shall do his work.”
Even where legislation defines an “employee,” as in the UK’s Employment Rights Act 1996 and New Zealand’s Employment Relations Act 2000, it is explained as someone engaged by another on a “contract of employment” or a “contract of service.” Unfortunately, the statutes give few extra clues as to what this means.
The body of case law attempting to classify an “employee” across the globe underscores the importance of the real nature of the relationship based on the facts, and not the labels given to it. A recent Poland Supreme Court judgment emphasized this. The ruling prevented a management board member who had registered as self-employed from taking advantage of lower social security contributions because the reality of his management contract belied his self-declared status.
Investigating the facts in tax status cases involves scrutinizing arrangements between the parties about paying for the services; the location at which services are provided; the tools and equipment used; the level of instruction about the work; and the ability of the worker to decide how to undertake the work, when they do the work, whether they can perform work for other employers, and their ability to make a profit.
And this gives a clue to the nature of the problem facing tax and other authorities seeking to determine the true nature of an employment relationship. While case law can establish some pointers as to what might be evidence of either employment or self-employment, in reality a relationship is as individual as the people and circumstances involved. Courts and tax inspectors scrutinizing a multi-dimensional arrangement in a two-dimensional setting can only hope to get it right some of the time. Enforcement is not always the easy answer.
National Responses
Of course, it has to be said that loss of tax revenue is only an issue for countries where the tax regime is favorable to the self-employed and incorporated businesses in comparison with the employed. Canada and Brazil have relatively minor differences in terms of the impact of tax and social security on the employed versus the self-employed.
But, in countries where an increase in the numbers of self-employed workers, or entrepreneurs, is leading to a loss of employment tax revenue, the authorities are taking a range of approaches. These include alternative tests, changes to established tax regimes and disincentives to reverse the trend.
United Kingdom. The UK government is considering responses to a recent consultation on proposed changes to tax legislation known as IR35, which was introduced in 2000 to tackle avoidance of employment taxes by those working through the intermediary of their own private limited company. With compliance with the legislation estimated at just 10% and losses of £450 million each tax year, the government needs to close a loophole that potentially leads to unfairness in the employment tax system, while continuing to encourage flexibility and genuine enterprise in the business community.
The proposed solutions lack innovation, though, and each is sure to upset one, if not all of the community of engagers, service providers and workers, against whom they are targeted. The options are:
- The person engaging the services of the worker should determine the nature of the relationship and withhold the correct amounts of income tax and social security contributions;
- Simplifying the employment status test to a determination of whether the worker is under the supervision, direction or control of the employer; or
- Requiring an engagement that lasts beyond a minimum period of time to be considered one of employment.
Netherlands. The tax authority is challenging employers to engage contractors correctly by changing the rules under which an independent contractor applies to the authority for a declaration of independent contractor status (VAR) which then absolves the client from any tax liability. The change which comes into force in April 2016, with transitional arrangements for existing contracts, is a requirement for work to be carried out on the basis of an approved self-employed agreement, submitted to the authorities. If the work turns out not to be consistent with the terms of the agreement both parties are liable for unpaid tax.
Italy. Legislative changes known collectively as the Jobs Act have ruled that all “collaborations” where a self-employed individual provides exclusively his/her personal services to a principal that organizes the individual’s execution of the work shall be considered employment. This is an effective prohibition on so-called VAT self-employed workers and there is also a ban on the use of “project” contracts except in certain specified professions and categories of job. These changes were tempered by a liberalization of the laws permitting fixed term employment and staff leasing by employment agencies, with the intention of encouraging more stable forms of employment. It remains to be seen how this will impact the contingent work market but Italy is the only European country in which SIA (publisher of this newsletter) forecasts double-digit (18%) growth in the market in 2016.
It appears that these governments are reverting to tried-and-tested models of employment, on the one hand because this is the easiest method of collecting taxes; and on the other hand because changing the tax system altogether will take time, and may lead to unintended consequences that need to be considered.
In the meantime, with labor costs and the burden of employment law and regulation on an upward trend, employers are looking for ways to reduce costs and avoid administrative burdens.
If being an independent contractor is becoming less attractive for contingent workers and employers in these jurisdictions, what are the alternatives? Is this an opportunity for the professional employer organization, well-established in the US but under fire with targeted tax changes in the UK?
Next month, I will look at how the removal of tax relief on travel and subsistence expenses is going to shape the UK contingent work market.
