Misclassification of employees as independent contractors generates a lot of column inches in the US, but it is not just a North American problem. Governments the world over are wrestling with increases in the numbers of individuals providing their services in a quasi-business relationship, as opposed to an employment relationship. The loss in tax revenue, where business taxes have traditionally been more favorable than personal income taxes, and the loss of protection for vulnerable dependent workers forced into working through corporate structures, concerns governments across the globe.
While the independent workforce in the US grew by 12% over the past five years to reach almost 18 million, a report published by the European Forum of Independent Professionals in conjunction with the UK’s Association of Independent Professionals and the Self-Employed (IPSE formerly Professional Contractors Group) found 45% growth in independent professionals (what they call iPros) across Europe over a 10-year period ending in 2013. This makes them the fastest-growing group in the EU labor market.
The conundrum is companies that use the workers’ services, and the workers themselves, enjoy the financial benefits of different taxation regimes, and in many cases the protection from liability for unpaid withholding taxes, through the use of the corporate veil.
Under UK tax legislation, known as IR35, contractors must pay income tax and social security contributions on income earned from engagements that are deemed to be “employment” as opposed to“self-employment.” However, the government estimates compliance to be at only 10%, resulting in a loss of £450 million annually.
That’s just the UK. In the US, the last comprehensive estimate of the number of workers improperly classified was for the tax year 1984. At that time, the US Internal Revenue Service found 15% of employers misclassified 3.4 million workers as independent contractors. This resulted in an estimated total tax loss of $1.6 billion in Social Security taxes, Medicare taxes, federal unemployment taxes and federal income taxes for that fiscal year. The IRS has included a worker classification study in its ongoing National Research Program (NRP), but the results are not yet available.
Enforcement is one side of the problem. In most jurisdictions, the classification of employment status depends on the right of the putative employer to control the worker. In practice, the determination of control is a complex exercise involving an investigation of all the facts of a specific relationship between the worker and the employer. As a result, lawmakers are looking at alternatives such as imposing arbitrary time limits on assignment length before the worker is deemed an employee (UK); or the relationship is converted into an open-ended employment relationship (Italy); or extending liability for unpaid taxes to the engager of the personal services (Netherlands).
Low levels of awareness of sham contracting and a lack of bargaining power on the part of the worker are another part of the problem, according to the Australian Building and Construction Commissioner, whose 2011 report found misclassified contractors in the Australian building sector tended to include non-English speaking workers, and be less attached and more transient in their role.
Invariably, workers are presented with a fait accompli or a version of the facts highlighting the apparent financial benefits to them of contracting; but with many individual workers unaware of their rights, they lack the information to make an informed choice. This has led government authorities, trade unions and even attorneys to campaign on behalf of those who are viewed as exploited by employer-driven arrangements.
One of the most high profile campaigns is that of the US attorney Shannon Liss-Riordan and her firm Lichten and Liss-Riordan, P.C., against Uber and the so-called “sharing economy.” They claim to have represented thousands of employees who have been misclassified in the US. “At our firm we think it’s important that the workers’ side of that equation have strong advocates fighting for them, or else they will just be walked all over. They will be exploited. That’s inevitable. We’ve seen that forever,” Liss-Riordan says.
There is no quick fix. As governments wrestle with the problem, it is clear that the binary notion of working relationships as consisting of employment or self-employment, and the systems set up to support that notion, are no longer adequate to reflect the rapidly changing forms of flexible working.
Next month, I will highlight some of approaches adopted by countries to tackle misclassification.