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Determining the employment status of individuals is problematic for employers. Confusingly, there are three distinct situations, each with its own set of rules.
- Who is an "employee" for employment income (including PAYE) purposes? The Income Tax (Earnings and Pensions) Act 2003 (s.4) states that "employment" includes employment under a contract of service, under a contract of apprenticeship, and in the service of the Crown. Office-holders, agency workers and workers supplied by intermediaries, despite not working under contracts of service, are treated as being in employment for this purpose (s.5 and ss.44-61). An "employee" is a person in such employment.
There is no statutory definition of "contract of service". According to case law, the existence of a contract of service depends on whether two critical factors are present in the relationship between an individual and an employer, namely:
- "mutuality of obligation", i.e. under the terms of the contract the individual is required to perform work and the employer is required to pay for that work, and
- the "degree of control" exercised by the employer over the individual's work.
In practice, those factors are very difficult to apply in specific cases. According to the Court of Appeal in the case Hall (Inspector of Taxes) v. Lorimer (1994), "an approach which suits the facts and arguments of one case may be unhelpful in another. This is not a mechanical exercise of running through items on a checklist to see whether they are present in, or absent from, a given situation. The object of the exercise is to paint a picture from the accumulation of detail. The overall effect can only be appreciated by standing back from the detailed picture which has been painted, by viewing it from a distance and by making an informed, considered, qualitative appreciation of the whole". This "picture-painting" approach is difficult for employers to take, particularly when evaluating the employment status of contractors, i.e. should they be treated for PAYE purposes as employees or as self-employed?
- Who is an "employee" for employment rights purposes? The definition of "employee" for rights such as a written statement of employment particulars, an itemised payslip, guarantee payments, maternity/paternity/adoption/parental leave, notice of termination, dismissal and redundancy, is provided in the Employment Rights Act 1996 (s.230).
An "employee" in this situation is "an individual who has entered into or works under (or, where the employment has ceased, worked under) a contract of employment". A "contract of employment" is further defined as "a contract of service or apprenticeship, whether express or implied, and (if it is express) whether oral or in writing", creating an overlap with the Situation 1, above.
Agency workers, who do not by definition work under a contract of service because the mutuality and control requirements are not both met by either the employer or the agency, are not employees for these employment rights. However, a minority of agency workers have contracts of employment with the agency that supplies them and, as a result, are entitled to these rights.
- Who is a "worker" for employment rights purposes? Rights such as protection of wages, statutory holiday pay, national minimum wage and flexible working are available to "workers", not just to "employees". The definition of "worker" is set out in the Employment Rights Act 1996 (s.230) and in various other related Acts that govern these rights.
A "worker" is
- an "employee" as explained in Situation 2, above, or
- an individual who works under "any other contract, whether express or implied and (if it is express) whether oral or in writing, whereby the individual undertakes to do or perform personally any work or services for another party to the contract whose status is not by virtue of the contract that of a client or customer of any profession or business undertaking carried on by the individual".
This rather convoluted definition means, firstly, that an individual who runs a business and does work for customers and clients of that business, i.e. a self-employed person with an established business, is not a "worker". Secondly, it means that an individual who works for an employer but is not set up as a business, i.e. a self-employed contractor, is a "worker" and entitled to all of the relevant employment rights. For example, many employment tribunals have recently awarded unpaid holiday pay to self-employed contractors who have extended contracts with employers.
Agency workers, although they do not normally meet the definitions of a "worker" are nevertheless specifically brought into the scope of some of these rights, in particular, those set out in the Working Time Regulations 1998 and the National Minimum Wage Act 1998.
These three different situations that govern tax liabilities and employment rights can create serious difficulties for employers. Although many employees fall into all three situations, some individuals fall into only one or two situations. For example:
- An individual who genuinely runs a self-employed business is not a worker (Situation 3) but may need to be treated by an employer as an employee for Situations 1 and 2 where the working relationship under a particular contract indicates that it is a contract of service.
- Agency workers are paid under PAYE (Situation 1) but are not normally entitled to the rights under Situation 2. They are, however, entitled to some of the key rights under Situation 3.
- Self-employed contractors who work under a single contract may or may not be employees for Situations 1 and 2, depending on whether the working relationship under a particular contract indicates that it is a contract of service. Even if they are treated as self-employed for Situations 1 and 2, they are nevertheless likely to be workers under Situation 3 and thus entitled to holiday pay and some other benefits.
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