What is a disguised employee?
Related to the IR35 legislation, a ‘disguised employee’ is someone that is:
- Self-employed, working through their own limited company;
- Engaged to do work for a particular client;
- And to all intents and purposes, would be an employee if it wasn’t for the fact of being engaged via their limited company.
Disguised employee: in a nutshell
And importantly, being a disguised employee is not usually a deliberate decision or conscious choice, writes Julia Kermode, founder of independent work champion IWORK. More often it happens by accident, sometimes due to lack of knowledge on the part of your client.
For example, the client may not realise that treating you in the same way as an employee is unhelpful and can end up being very costly.
So be alert to the possibility of disguised employment gradually creeping up on you – you might start an assignment being undisputedly self-employed, but behaviours can easily drift.
What does disguised employment actually look like?
Disguised employment occurs when working as a contractor, and either you or your client behaves as if you are an employee of the client.
Crucially, the outward appearance may be a business-to-business relationship (because there is your limited company engaged by the client’s company or organisation), but actually, the reality of your relationship – if the ‘disguise’ of your corporate structure was removed, would be one of employment.
To ensure you do not become a disguised employee, it might be helpful to consider the typical employment tests which would result in an “inside IR35” determination (i.e. a determination which in effect says despite your limited company operation, you are actually akin to the end-user’s employee).
As much as you can, you need to fully control, how, where, and when you work, and what work you do, to avoid becoming a disguised employee. If your client is able to dictate too much control in these aspects, then you might not be genuinely operating independently of your client, and could therefore be a disguised employee.
As your client has engaged the services of your company (not you personally), then you should be able to use a substitute to complete the contracted work. You would source and pay the substitute at your own cost, and the client would continue paying your company for the agreed work. However, if your client dictates that you personally undertake the work, this has the strong potential to indicate disguised employment.
Mutuality of obligation
In an employment relationship, the employer has an obligation to provide ongoing work and the employee has an obligation to do the work. As an independent contractor, you should avoid falling into any similar circumstances in order to prevent becoming a disguised employee.
The above list is a very simplified rundown of the potentially many factors that can point towards disguised employment. The above is merely an overview of the key disguised employment indicators.
However the reality of employment status isn’t usually as straightforward. There are lots of factors that would be considered by an IR35 or status expert in deciding your true IR35 status, both contractually and in terms of working practice. They would assemble the many facts in and around these areas to form a ‘big picture’ of your engagement, and whether it smacks of disguised employment or not.
Why does it matter?
It matters because if you are a disguised employee, you are quietly, covertly and at odds with your limited company appearance, really “inside IR35” and so risk ending up with a very large tax bill, possibly going back up to six years.
IR35 was introduced in 2000, reformed in April 2017 in the public sector, and reformed in April 2021 in the private sector. Broadly, the legislation (also known as the off-payroll rules) seeks to ensure that disguised employees who are engaged via their own limited company pay tax as if they were employees.
What if I’m a sole trader?
If you are a sole trader and your working relationship with a client could be considered disguised employment, then it is your client who has the financial risk, i.e. HMRC would consider them liable for PAYE, Employer NICs and Employee NICs, on top of the monies paid to you. This is a key reason why many clients prefer not to engage contractors who operate as sole traders.
How to protect yourself
You need to be aware of the factors which might indicate disguised employment, and prevent them coming into play, in both your written contract and your working practices. You may need to educate your client too, as they may not realise the importance of treating you differently to an employee.
The very simplest way to not be a disguised employee is to always ensure that you are genuinely in a business-to-business relationship with your client, and that you are operating independently of your client. If you ensure that this B2B mentality, approach and execution is paramount in all of your dealings with your client(s), then the chances of being a disguised employee are minimised.