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HMRC internal manual

VAT Taxable Person Manual

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Issues to consider: Employment status: A contract of service or a contract for services?

“Contracts of employment”, also called “contracts of service”, are made between employers and employees. Typically, they will describe the nature of the appointment, and detail the terms of control, hours of work, and rates of pay. Such contracts will also provide sick, holiday, and maternity pay, and will explain both the machinery for resolving disputes and termination arrangements. Earnings under these contracts are outside the scope of VAT.

Someone who is engaged under a contract for services is self-employed and his earnings are in principle liable to VAT.

There is no statutory basis to help you distinguish these two types of contract. As indicated in VTAXPER33500, the approach should normally be the same for direct tax and VAT. However, each case must be considered on the following basis.

All the facts of the case must be established to determine the nature of the contract between the parties. The terms of an appointment can be written, oral, implied, or a combination of all three. Where there is a written contract, you should get a copy. Remember, however, that there may also be oral or implied terms to be established and other documents which may throw some light on the terms of engagement to be obtained.

In reaching a decision, reference has to be made to all the factors surrounding the appointment. The observations of various court cases are also useful in this context. In the words of Cooke J in Market Investigations Ltd v The Minister of Social Security (1968) 2QB173, there is no exhaustive list of factors which bear on the relationship between the parties, nor can strict rules be laid down about the relative weight of each factor.

As a result, all factors have to be considered in any given case and each factor needs to be given its appropriate weight depending on the circumstances of each case.

Some factors are outside the terms of the particular contractual relationship being considered: they are more personal to the worker. The direct tax case of Hall v Lorimer is relevant here. Mr Lorimer was a vision mixer and the Court of Appeal found it significant that Mr Lorimer customarily worked for 20 or more production companies and that the vast majority of his engagements lasted for only a single day. Mr Lorimer was found to be self-employed.

a. Factors to be considered

The following are some factors that the courts have found relevant in considering the status of workers.

  • Whether the individual is in business on his or her own account This is the approach taken by Cooke J in the Market Investigations case and represents the first basic step in the issue of the worker’s status. He asked Is the person who has engaged himself to perform these services performing them as a person in business on his own account? If the answer to that is “yes” then the contract is a contract for services. If the answer is “no” then the contract is a contract of service.
  • The degree of control exercised Generally, a contract of employment will give the employer a right of control over the worker. This can cover what the worker has to do, where, when and how the worker has to do it. The extent of this right will vary, however. What is important is the right of control. In practice an employer may never exercise this right.
  • Substitution rights A contract of employment is the provision of personal service. Where an individual is free to hire someone to carry out his or her duties or to get substantial help from someone else, it is likely the individual will be self-employed.
  • The provision of equipment A self-employed contractor generally provides his or her own tools but an employee will be provided by the employer with the necessary equipment to do the job.
  • Risk of loss and the prospect of profit An employee usually does not need to risk his own capital, whereas a self-employed person will normally bear an amount of financial risk in order to operate. An employee’s income may relate to performance - for example, a piece rate - but employees are not generally in control of whether a profit or loss is made in the work undertaken.
  • Basis of payment Typically, an employee is paid by the week or month while a self-employed contractor is paid a fixed sum for the work undertaken.
  • Existence of sick pay, pension rights and holiday pay Only employees are entitled to statutory sick pay and membership of a firm’s superannuation fund is normally only open to employees. However, these are indications of the relationship the parties think they have created rather than a test of whether employment status exists. For example, these benefits may not apply to employees on short-term contracts, but this will not affect their status as employees.
  • The exclusivity of the service, number of contracts held A typical employee works for only one employer whereas the typical self-employed contractor is ready to work for anyone and may have a number of contracts operating at once. This, of course does not preclude an employee taking on more than one contract of employment at any one time.
  • Whether part and parcel of the organisation’s structure A self-employed adviser might clearly be carrying out a business separate from the organisation for which the work is done: for example, a marketing expert providing advice from time to time for a fee. However, it can often be very difficult to decide whether a person works as an integral part of an organisation. The courts have recently tended to play down the importance of this test.
  • Right of dismissal A power to terminate an engagement by giving notice of a specified length is indicative of a contract of employment. A power to terminate only when there has been a breach of contract is more usually found in a contract for services.
  • Intention of the parties It is the reality of the parties’ relationship that matters, but the intention should be taken into account. It will be particularly relevant if other factors fail to provide an answer to the question of the workers’ status.
  • The traditional structure of the profession For rules in respect of particular trades, see VTAXPER60000.

b. How to decide

Having established the facts, you must consider whether factors referred to above which are relevant to your case are more consistent with a contract of service or a contract for services. This is not a mechanical exercise but more a matter of reaching a balanced qualitative assessment from all the facts. It is vital that you take a well-considered and rounded view based on the reality of the situation. More detailed guidance on the factors which will help determine whether a contract is a contract of service (employed) or a contract for services (self employed) can be found in the Employment Status Manual (ESM).