A disguised employee, simply defined, is a worker who carries out their work in the way an employee would, whilst operating through an intermediary - i.e. a limited company.
Before the introduction of IR35, there was nothing in legislation that prevented a worker that would otherwise have been considered an employee from operating through a limited company and receiving the tax benefits of doing so.
An employee will typically:
- have a level of Mutuality of Obligation (MOO) in their contract
- be subject to the control of the employer in the way they work
- be obligated to provide the services personally, they will not have a right of substitution
- not bear any financial risk
IR35 poses the question; in the absence of the intermediary (limited company) would the relationship between the end hirer and the individual be one of employment? If the answer to this question is yes, then the contract will be one of ‘disguised employment’ - i.e. inside IR35.
It is understanding what constitutes an employment relationship that is key to IR35.
What determines a disguised employee?
We’ve discussed three major IR35 determining factors in previous articles; substitution, control and Mutuality of Obligation; we summarise each factor below:
Substitution: The presence of a substitution clause in a contract may lend weight to falling outside IR35, but it is the reality of the relationship in practice which holds more weight when IR35 status is under scrutiny. When considering the employment status of a contract, having a right of substitution points away from an employment relationship.
Control: Demonstrated through a degree of autonomy in how the work is carried out. In a genuine business to business relationship, the end hirer is not expected to exercise the same level of control as they would over an employee.
Mutuality of Obligation: MOO can be displayed in many ways. The demonstration of an obligation from the end hirer to provide work, and the contractor to accept it, is the crux of mutuality of obligation. You can read more about MOO in this article.
Tax Reliefs and Benefits: Employees vs Contractors
Contractors are entitled to certain tax reliefs and benefits an employee would normally not be privy to.
Typically, running a limited company will give more opportunity for tax planning by allowing the contractor to structure their income in the most tax efficient way.
Further benefits include flexibility in the work the contractor chooses to accept, and the freedom of being their own boss. Setting up a limited company will mean that although a contractor will pay corporation tax on business profits, they save on NI and income tax.
An employee enjoys numerous freedoms a contractor does not. They take on no financial risk, workflow is guaranteed (to an extent), and there is no financial risk when conducting normal work for the employer. Employees would carry less business stress – in that there is no need to chase work (they’ve been employed to fill a gap in existing work as it is), and HR departments take care of the legal and tax compliance for them. They’re guaranteed a certain number of paid holidays, and don’t ordinarily find themselves working out-of-hours to finish an assignment.
Employees are typically privy to the benefits we outlined above, but generally speaking they will pay more tax.
If you’d like advice or support regarding IR35 compliance, avoiding disguised employment or any other related information, contact us here at Parasol.
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