In my 15 years working in the Irish tax and accountancy industry, I have come across this question frequently. Both from my clients and from business owners whom I have got to know through business support and networking groups.
Bottom line, there is a LOT of confusion about this.
We work with many Irish recruitment agencies and large Irish businesses in engaging and paying contractors. Using freelancers and independent contractors can bring just as many benefits to small businesses as they do to big business. Freelancers enable businesses to access a skill set for a period needed by the business. For small and start-up businesses particularly, this can be very helpful given that cash flow, budget and business development uncertainties may be an obstacle to the business taking on a permanent or fixed term employee.
Where can employers go wrong when it comes to engaging freelancers?
A big problem I see are businesses engaging an individual as a freelancer, when in fact that individual should really be treated as an employee. In essence, a misclassification problem.
I often hear explanations such as:
"They are a casual member of the team. They only come in when I have work for them”.
"It’s ok, they know they have to look after their own taxes. In fact, we’ve even signed a contract which says they, not me, are responsible for the paying the taxes.”
“It’s their preference to be treated as a freelancer. I gave them the option of both, but they said being a self-employed freelancer would suit them better”.
“It’s normal in our industry that people work for businesses as freelancers rather than employees”.
Misclassification is usually a genuine error due to lack of information and understanding on the tax and legal requirements.
Why does misclassification matter?
It matters because getting it wrong can be an expensive mistake. If Revenue conduct an audit of your business and see that individuals have been paid as self-employed, when in fact they should have been treated as employees, you can be hit with a big tax bill equivalent to the amount of payroll tax which should have been charged. As well as the taxes, they can also charge you interest and penalties. The costs add up very quickly.
How do you know when it is ok to engage an individual as a contractor rather than an employee?
The level of supervision, direction and control (SDC) is a key indicator of an individual’s employment status. It’s become a hot topic in the UK and is just as relevant in Ireland. The higher the level of supervision, direction and control exerted over the individual, the higher the likelihood that they should be classified as an employee.
To understand out how this works in practice, the following guidelines from the Code of Practice for Determining Employment Status, will help you in classifying individuals correctly as employees or as self-employed freelancers.
It is not necessary for a person to meet all the criteria shown below before you can classify them as an employee or self-employed contractor. However, a clear picture should build up for you when you consider how many of the criteria in each category are relevant to the individual and your arrangement with them.
Criteria which indicates that a person is an employee
- They work under the control of another person who directs them as to how, when and where their work is carried out.
- They receive a fixed hourly, weekly or monthly wage.
- They cannot subcontract their work.
- They work set hours or a given number of hours per week or month.
- They work for only one person or business at a time.
- They supply only their labour and do not provide materials, tools, equipment to carry out their work (other than small incidentals).
- They are not exposed to personal financial risk in carrying out the work; for example, if they did a poor job they would still have to be paid.
- They do not have the opportunity to vary the amount of financial profit they make from the work, by using their own control and choice of how they carry out the work.
Criteria which indicates that a person is a self-employed freelancer
- They own their own clearly identifiable business which is separate to the work which they are carrying out for you.
- They have control over what is done, how, when and where it is done and whether it is themselves personally who do the work or another individual.
- They control the hours of work in fulfilling the outcome obligations of the job.
- They are free to hire other individuals to carry out the work.
- They can provide the same services to more than one person or business at the same time.
- They are exposed to personal financial risk in carrying out the work such as by having to bear the cost of making good on any substandard work carried out, or footing the bill for time overruns.
- They have the opportunity to vary the amount of financial profit they make from the work, by using their own control and choice of how they carry out the work.
Some additional points to be aware of are:
- Just because an individual is registered for tax or VAT, it does not mean that your business can automatically treat them as a self-employed freelancer.
- A contract or agreement between yourself and the individual stating that you have both agreed for the individual to be treated as a self-employed freelancer, does not supersede employment and tax law. You can both agree to a self-employed arrangement only when the rules and criteria apply to your situation.
- An individual could have considerable freedom and independence in their job, but still be an employee.
- A person can be self-employed in one job and an employee in another job simultaneously.
- Some employees can work for more than one employer at a time.
- Paying an individual using commissions or project fees, doesn’t preclude them from being an employee.
Making a final decision on classification
Do these guidelines always lead you to a black and white answer?
No, not always. That would be too easy right? Sorry!
As you can probably imagine, in certain situations it can be difficult to determine if an individual is a freelancer or employee, even when trying to follow the guidelines. There are a lot of elements to consider when forming your conclusion. However, to attempt to simplify the issue a little, from experience the following are key factors to focus on:
- The ability to substitute. Very few employments allow an employee to arrange for a substitute not employed in the business to carry out their work.
- The ability to bring in additional or alternative people to carry out work. This point is very linked to the point above.
- The level of DSC exercised over the individual.
Using Limited Companies to mitigate risk
One method of reducing the risk of freelancers and independent contractors being treated as your employee is if they provide their service to you through a Limited Company or Umbrella Company. The reason this reduces risk is because a limited company cannot be deemed to be an employee. The limited company should then operate payroll taxes on payments to the freelancer.
If you are still unsure, it is best to seek advice. This could be from a good tax advisor, accountant, HR advisor or employment law expert who has experience in employment classification.
You can also seek a decision on the situation from Revenue or the Department of Social Protection. If contacting Revenue, you should contact your Local Revenue Office. If going to the Department of Social Protection, the relevant division to contact is Scope Section.
You can contact Scope Section on 01-6732585 or firstname.lastname@example.org
You can find the contact details for your Local Revenue Office at http://www.revenue.ie/en/contact-us/index.aspx