An employer is required by law to deduct PAYE tax and employee Class 1 National Insurance contributions (NICs) from the earnings of employees and also to pay employer Class 1 NICs on those earnings. If an employer fails to do so and pays a person on invoice when that person is really an employee, the employer is liable, in the event of a compliance audit by HM Revenue & Customs (HRMC), to pay all of the tax and NICs that should have been deducted and paid, plus up to an additional 100% as a penalty.

Some employers have had to pay penalties of £50,000 and even £100,000 for getting this wrong. Employers cannot afford to make such a mistake and, as directed by HMRC, "almost everyone who works for an employer will be employed under a contract of service, including full-time, part-time, casual or temporary employment". (HMRC's CWG2 booklet, page 6) (See Who are employees for PAYE purposes?) If an employer is in any doubt as to whether a person is or is not an employee, the safe course is to put the person on the payroll. If the decision to put someone on the payroll is subsequently changed, the PAYE tax and NICs can always be refunded.

If your client has decided to put you on the payroll and deduct tax and NICs from payments made to you, the client has presumably decided that you are engaged under a "contract of service". That is a decision that the client must make by law and it should be respected, even if you feel that it is wrong. At the end of the tax year, when you complete your self-assessment tax return, you will report the earnings paid and the tax deducted by this client on the employment page of your tax return, so you will not end up paying more tax than if you were paid on invoice. (See What is the difference between a "contract of service" and a "contract for services"?)

If you feel you have paid more NICs than you should have done, HMRC also has arrangements for excess NICs to be refunded. Alternatively, you may apply for your Class 2 and Class 4 NICs liabilities to be deferred until your true liability has been worked out after the end of the tax year. (See www.hmrc.gov.uk//nic/deferment.htm)

Some people who claim that they are self-employed object strongly to being put on a client's payroll. As the tax and NICs deducted through the payroll can be fully offset against tax and Class 2 and Class 4 liabilities due on profits from self-employment, an employer would be entitled to conclude that the person is not declaring all earnings to HMRC.

If this explanation does not answer your question and you cannot find the answer to your question by doing a search elsewhere in PayPerShop, please click here and explain what it is that you still do not understand.

Is there another question you would like to see answered in PayPerShop? If so, please click here and send us your question.