Office of Tax Simplification: 'lack of clarity' around self-employment status for tax purposes must be addressed

Self-employment is not currently defined by UK law and different employment status tests are used for tax, employment law and pensions auto-enrolment. Reporting on the complexities of the existing system and making recommendations for improvement, the OTS said that the existing self-employment indicator operated by HM Revenue and Customs (HMRC) was a "valuable resource", but it required significant expansion and reliability improvements.

Better guidance and a new helpline could assist firms in the short term, the OTS said. However, it has recommended that the government consider "longer-term" improvements such as possible 'de minimis' period of time or level of payment before employment status needs to be considered; or the potential introduction of a 'statutory employment test'. It has also repeated its previous recommendation to combine income tax and national insurance contributions (NICs).

Employment tax expert Jon Robinson of Pinsent Masons, the law firm behind Out-Law.com, said that the conclusion by the OTS that there were no "quick wins" or easy solutions to problems around employment status was unsurprising.

"With increasing flexibility and changing patterns in the workplace, it is true that the case-law based tests of whether or not a person is an employee for tax or employment law purposes are increasingly difficult to apply with confidence to factual situations that sit somewhere in the middle of the spectrum of employment versus self-employment," he said.

"As has been seen with the statutory residence test introduced in April 2013, it is possible to try and compartmentalise a process that involves weighing up different factors to try and provide some degree of certainty and predictability, and it is interesting to see that the OTS recommends taking further the idea of a statutory employment test," he said.

The OTS was set up to provide the UK government with independent advice on how to simplify the tax system. Employment status is the last area it intends to formally review, following previous projects on issues such as small business taxation and employee benefits and expenses. In its report, the OTS said that its work was not to "solve" the existing uncertainties but rather to consider the underlying problems and trends and develop potential means of improvement.

The report identified both direct ways of simplifying the tax rules in this area, such as streamlining definitions; and indirect ones, designed to "take the heat out of the issue". Some of these could be acted on in the short to medium term, while others were "promising routes to reform that warrant further work but which would mean major changes", according to OTS tax director John Whiting.

Ideally, the OTS would like HMRC and the relevant government departments to work together on a coherent set of principles, developed from case law, to guide and govern decisions on employment status, according to the report. However, if this cannot be achieved in practice, it would be "surely desirable that for tax purposes some clearer guidance is developed, including principles". This could also feed into work on improving HMRC's employment status indicator tool, according to the report.

All of the government's guidance material on employment status should be brought together in some kind of "employment status portal", covering both tax and employment rights, according to the report. HMRC should also set up an employment status 'helpline' with more resources and training allocated to it, while specific help should be set up to assist individuals and small businesses at the point of engaging a self-employed person in order to "preclude or reduce the burden of" HMRC enquiries.

Longer term recommendations included the possible introduction of a set 'de minimus' level, meaning that somebody who is paid under a certain amount or works for no longer than a defined period would never be regarded as an employee; backed by safeguards to prevent unscrupulous employers from forcing employees to take a succession of these roles. A statutory employment test, whether in the form of a detailed reflection of all relevant case law or a "simple and pragmatic" set of rules should also be explored, the OTS said.

The report also considered the introduction of a "third way" intermediate employment status, between employed and self-employed. The OTS has not included this among its recommendations due to perceived difficulties in setting it up fairly, but has asked for further comment.

Whiting said that the fact that employment and self-employment were treated differently for tax purposes, particularly in relation to employers' NICs, was "the elephant in the room of reform". The government must conduct a full study into aligning tax and NIC rates, as well as the benefits available to employed and self-employed people, he said.

"The tax system is stuck in an out-of-date mindset," he said. "In the 1950s and 1960s the distinction between employees and the classic self-employed jobbing plumber was clear and easy. Nowadays, working patterns are hugely varied, freelancing is a way of life for many and that simple split doesn't work often enough. This causes uncertainty, risk and administrative burdens all round."