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Tax and false self-employment in the construction industry

by Michael Smith
NBS Information Specialist

As many as a million workers are making a false claim to be self-employed, and earning up to £100 a week more than their directly employed colleagues; depriving HM Exchequer of a calculated £350 million a year. This article looks at the recent Treasury consultation, False self-employment in construction: taxation of workers, and its possible implications.

False self-employment

At Budget 2009, the Government announced that it remained committed to addressing the problem of false self-employment in the construction industry and would consult with a view to future legislation. False self-employment occurs where workers are treated as self-employed for income tax and National Insurance (NI) purposes, despite the fact that the way in which the work is carried out on a day to day basis demonstrates that there is an employment relationship.

HM Revenue and Customs has been continually planning and implementing crackdowns in recent years, usually through changes to the construction industry tax scheme (CIS). However, the Revenue's latest plan is to scrap the CIS and tax all workers at source using PAYE.

This may sound like a simple step, but its importance for the whole of the industry is difficult to overstate. The principal effect will be to impose external control on a large area of the industry.

How will it work?

The Government believes that the introduction of legislation, which moves away from the current case law approach and applies specific criteria to the engagement of workers in the construction industry, is the best way to address the issue of false self-employment.

The Government proposes that:

"where a person, (the engager) whose main business involves the carrying out or commissioning of 'construction operations' (as defined for the purposes of the Construction Industry Scheme (CIS)), uses the services of a worker to carry out such operations, then the payment received in respect of those services will be deemed to be employment income."

This 'deeming' will occur unless the worker fulfils one of three statutory criteria. Any payment made to the worker which is deemed to be employment income will be subject to Pay as You Earn (PAYE) and NICs.

It is the activity that the worker is actually performing for the engager to which the criteria would be applied, regardless of who pays the worker.

What the proposals do not say is that the worker must be classed as an employee, just that tax and class one NI contributions must be deducted from the payment. Those firms who say they need casual workers for flexibility will still be able to have them.

The cunning part of the proposals is where it is the wage payer who will be responsible for paying the money to HMRC. This may be a killing blow for those intermediaries and agencies that deal in construction's self-employed labourers.

Who would apply the 'deeming' test?

Although it is the work done for the engager that is relevant for the deeming provision, the person responsible for making the payment to the worker (the payer) will have to apply the statutory criteria. The payer could be the engager, an Employment Agency or an intermediary. The payer will also have responsibility for applying PAYE and NICs to the amount of employment income and accounting for employer's NICs.

Benefits of the 'deeming' provision

The introduction of a deeming provision in legislation means that it is clear who has responsibility for applying the statutory criteria which determine whether the worker's income is to be treated as employment income, and the facts and circumstances of the engagement are key, rather than the contractual terms that are presented.

The self employment criteria

The Government believes that the following three criteria meet those requirements and are reliable indicators, within the context of the construction industry, of a worker being in receipt of self-employment income:

Provision of plant and equipment – that a person provides the plant and equipment required for the job they have been engaged to carry out. This will exclude the tools of the trade which it is normal and traditional in the industry for individuals to provide for themselves to do their job
Provision of all materials – that a person provides all materials required to complete a job
Provision of other workers – that a person provides other workers to carry out operations under the contract and is responsible for paying them.

Who will be affected?

The proposed changes will alter the employment conditions of two groups of workers: those who become companies and so do not pay payroll taxes or National Insurance (NI), and workers supplied by labour agencies.

Individuals as companies

The Revenue service estimates that around 300,000 subcontractors claim to be self-employed, even though they do not bring their own tools and take instruction like any other worker. Under the new proposals, they would be taxed by PAYE and the Revenue service would also levy income tax and National Insurance (NI).

For firms employing these workers it means that they, as the employer, will have to pay the contribution to NI, adding 13% to their wage bills.

Agency workers

Also proposed to be taxed at source are workers supplied by labour agencies. This could be the death knell for agencies that are simply 'factories for avoiding PAYE'.

Implications of the change

The most obvious change will be that contractors and housebuilders will have to pay more for their workers. However, some employers may have other motives for lamenting the proposed changes. A genuine subcontractor relies on its contract and the provisions of the Construction Act to regulate dealings with the employer. An individual presenting themselves as a company does not, nor are they protected by employment law.

On the other side of the argument, the construction industry needs to routinely mobilise and demobilise labour, and self-employment through the CIS is rated by many as the most effective system, even though, under CIS, many self-employed are not offered training in health and safety or related skills.

For the unions, the proposal will form a partial victory. If the number of directly employed workers is increased, it is likely to greatly increase the labour pool that it can recruit from.

The proposals may also go some way, in conjunction with the Donaghy report, to address long standing industry and union concerns over 'vulnerable workers'. Under new legislation their terms and conditions will have to be more transparent, easier to understand and police.

Limitations

The proposed changes will define workers as employed, only for the purposes of NI and income tax. Employers will not be forced to give them holiday and sick pay. In this area the Revenue appears to be washing its hands of the issue and saying, "give us our tax, then you decide what the law says about sick and holiday pay."

Other means

A suggested fourth test, that the worker has to be VAT-registered before they can be considered self-employed, has also been mooted, though not yet considered. However, this would cover many of the true self employed; how many businesses can supply all the materials, or supply plant for a project, or provide and pay other workers without going over the VAT threshold?