The problem is caused by the IRS and HMRC having secondary effects that make employers do this - whether every subcontractor sound be a subcontractor an employee is a different issue.
There are arguments on both sides eg a Freelance Director of Photography is not going to want to be taxed as an employee.
It's not entirely true. Just because such right exists in the contract, does not mean it is valid. HMRC guidances have a ton of rules where it does not count. For instance if the business could use the sub-contractor directly.
> and freedom to work with multiple clients.
This is also irrelevant, because exclusive supply agreements is a normal business practice. Also people can hold multiple employments and that does not make them "contractors". People can also be contractors and employees at the same time and anything in between.
> If they get it wrong, they're liable for taxes, not the Contractor.
That's not entirely correct either. The client can claw the money back from the Contractor and very much every contract I have seen has clauses ensuring that any unpaid tax the client is liable for will be re-paid by the contractor.
Good luck with that. The IRS has very specific rules for who can be considered an employee and who can be considered a contractor. Attempting to treat people who should be employees as contractors is one of their number one enforcement goals, because contractors don't have withholding and are therefore far less likely to pay their taxes.
In the UK, the government has taken the view that in some sense, yes, some contractors who were claiming to be self-employed were in fact employees and therefore have to pay more tax (the same tax as other employees), and can claim fewer expenses against tax (also the same as other employees). The underlying principle is equal treatment.
There is no advantage to the individuals from that decision, nor is there any intended.
So people spending 5 years working for the same company doing the same commute and same work as employees, subject to the same kind of control over their work etc., cannot maintain a claim to be self-employeed for the tax flexibility that goes with that.
However. You "writing code" as a contractor is not the same work as an employee if the manner in which you are doing it differs.
For example, if you have to purchase your own equipment, set your own hours, work on a "statement of work" basis instead of set hours, can substitute a subcontractor to do your work for you, and can and sometimes do work for multiple companies at the same time, and often switch the site at which you are working, those sorts of things signify that you are not operating as an employee would, and that it would be correct to classify you as running your own business and therefore subject to business taxation instead.
Of course every contractor wanted to claim that status for the tax benefits, which are basically less income tax and the ability to deduct more expenses. The government saw this and decided, although the law was what it was all along, people weren't applying it adequately. So they changed who does the assesment, and the tax liability if they get it wrong, from the contractor to the company hiring them. This is called the IR35 reform; IR35 is the name of the legislation that sets out what kind of working patterns must be treated as employment for tax purposes.
Although the reform will change who is liable for making the assessment, in principle it is still possible for a contractor to be retroactively assessed for their past as having been an employee all along, and have to pay back-tax. That's because you are supposed to have done the right assessment for yourself already, or perhaps your accountant should. This seems unlikely for most people now as long as the changes are followed through, but some people have been caught out by it.
A big part of the problem with how the similar rule is implemented in the UK is that determining status falls to the company hiring the contractor.
The employer is legally liable for lost tax revenue if they fail to determine status correctly.
The result: most employers decided that contractors were inside (treated like an employee for tax purposes with none of the benefits of employment) rather than risk getting it wrong.
This might be related to the legal change for IR35, which is intended to prevent companies pretending that their employees are freelancers and thus making their situation more precarious against their interest. A bunch of companies got the wind up about the legal and tax liability and so are dealing with contractors in a more restrictive way. Others are still using contractors and just need to make sure that the legal situation is clear.
In the UK at least, if you are a contractor you are legally not an employee.
If you took any employee benefits, the tax man could retroactively classify you as an employee and demand a huge tax bill from you.
So many contractors would refuse any such benefits even if they were offered. Some didn't care of course and took them anyway, but they were potentially setting themselves up for a huge legal and tax problem.
That's not a problem. The point in the tax code is to prevent offloading the tax liability by classifying people who are rightfully employees as contractors instead.
I'm reasonably certain the tax code has no regulation that says you must be classed a contractor if you meet certain criteria.
The important caveat that is that in many jurisdictions, there’s a significant difference in the tax treatment of contractors vs. employees, and so by producing such a contract (that forbids subcontracting) you are plausibly creating an employment arrangement and are on the hook for tax consequences.
Here in the UK, for example, if you wrote such a contract, it would be enforceable… but you would be considered (by the tax authority) to be trying to evade employment taxes, and hit with something starting in the range of a low 5-figure financial consequence (assuming the contract was a few months at current average rate for tech workers).
All of my contracts explicitly allow subcontracting in order to comply with tax law.
In the UK there's a set of criteria (IR35) that attempt to codify the distinction. The hiring business has to make the assessment.
One of criteria is right to subcontract and freedom to work with multiple clients.
If they get it wrong, they're liable for taxes, not the Contractor.
HMRC, the UK tax body is responsible for this, and therefore it is an utter mess in practice and has had chilling effects on the UK IT consulting market.
They moved responsibility for determining whether a person is acting as an employee or a vendor in the vast majority of cases to the client, who must demonstrate a bunch of factors (I'm not a tax guy), not least
- the "vendor's" right to substitute himself for a replacement they subcontract (via employment or otherwise) to, irrespective of the client's deemed suitability of the chosen replacement
- the "vendor's" right to a significant level of autonomy, such as the ability to choose their working hours and lunches, and have high level control over their workflow
- the process of determination 'employee' vs 'vendor' must be significantly documented and can be challenged in retrospect for years after completion of the contract
Falling on the wrong side of a determination could leave the client liable for mandatory national insurance and pay-as-you-earn tax deductions. Now HMRC need not prosecute individual contractors, but instead clients (who may hire hundreds of contractors), making the enforcement process much more efficient for them, and much higher risk for the clients.
Net result for companies: building big overnight temporary teams out of contractors e.g. for 6-12 month projects are vastly less likely to do so, for fear that at some future date, the tax man could claw back a year's worth of tax for e.g. 20 contractors on the same project, with non-compliance and late payment penalties lumped on top (which themselves increase with respect to how long it took HMRC to get around to investigating you). It could be the case (hypothetically) that it would only require one member of a team to report the inability to substitute, or the presence of a line manager, for an entire project team's worth of tax to get a question mark placed next to it.
Net result for contractors: anyone who understands what's going on has either pivoted into becoming a permanent employee, avoiding the whole mess, since contracting is an expensive activity to begin with, and the premium has now been removed, or has banded with a few friends and attempted to set up "micro agencies". I've already encountered these, where substitution was advertised very early in conversation.
Net result for the market: it will be all but gone by April 2020.
Most places they don't prevent what you describe. There are usually just some extra hoops to jump through and/or some tax implications.
E.g. I'm in the UK. I've been a contractor with multiple contracts as well as with a single employer both in situations where they are obviously acting as an employer, and in situations where they were genuinely not.
Here there's specific legislation to handle this now - "IR35", which ensures that if your contract is equivalent to employment you'll be taxed accordingly, with an "umbrella company" acting as an employer on behalf of the company that you're contracting with if that is the case to prevent there from being a tax advantage from pretending to be freelance if you're in effect an employee. It doesn't stop you from doing it - it just takes away the tax advantage and creates some bureaucratic hurdles.
But it's easy to avoid as long as you're not trying to avoid taxes, by setting terms that ensures it doesn't match the criteria. Employers are often keen to do this, and it gives you extra negotiating power.
E.g. when I was doing this, key points involved the fact I had a small marketing budget to bring in additional work, I didn't usually work out of their office, I controlled my own hours, I determined how to carry out the work, I negotiated my day rate, the contract had a defined end-date (we could renew, but there are pitfalls there), and so on. Another strong sign you're genuinely not an employee is a right to substitution (e.g. if you can provide someone else to do the work, when you're not available and that right is genuine). UK tax authorities (HMRC) has a checklist as to what they consider "deemed employment" and or that falls under IR35 (it's not an absolute set of criteria, but basically the more you look like a business, the more likely you are to be considered one).
So for high earners like software consultants with an actual reasonable power balance vs. the other side, this is rarely a problem. It cost me a tiny proportion of my revenues to make sure that I met more than enough criteria to be able to do as I pleased.
But most of the people these regulations are there for are in a substantially weaker position. If you're a low enough earner to not be in a position to work around this, then you're not likely to have the power to genuinely negotiate either.
I think an awful lot of employers would prefer you were a contractor; in the USA at least, it is the IRS/government that prevents this from happening more by putting the fear into said employers that they will be fined and forced to pay back taxes for anyone improperly classifying people as contractors when they are in fact employees.
UK had great laws geared towards mobile workforce and specialist contractors could claim business costs against their tax - this combined with little bureaucracy and use of de facto lingua franca was a recipe for success. From April next year this will end as government was looking for extra money and decided to adjust IR35 (a law that essentially says if you work as an employee you should be taxed as employee, but without having any employment rights), so that now the client has to determine whether contractor is a deemed employee or not. The problem is that the penalty for doing wrong determination only exist if you declare that someone is not a deemed employee, but investigating civil servant finds the opposite. That means risk averse companies change their contracts so that the contractor will always be deemed an employee to avoid getting fined (the fine plus all taxes that would have to be paid even if contractor already paid all the taxes). This still wouldn't be a problem if the rules about deemed employment were clear - but after so many years HMRC still keep losing cases where they get the determination wrong themselves. What this means for contractors? They essentially become employees without rights and the effective tax rate they will pay may be even around 54% plus they won't be able to deduct any business expenses (except what employee could have deducted - but that is essentially dead). Suddenly the market for IT specialists in the UK became unattractive and companies who are struggling to find people working for severe pay cut start to look overseas.
edit: if you want more spice to this, then imagine that our Chancellor is married to woman that her and her father have substantial stake in Infosys.
The issue of tax evasion is really seperate to the fact that the changes in the law have killed the business model for the contractors. Being a payrolled employee in this case is worse for everybody involved, the employees most of all.
The point of the law is to stop people taking on contracts that should essentially be permanent employee roles. Its more tax efficient to be paid via your own Ltd company instead of as a PAYE employee, especially when you get into the highest tax bracket, and so the government loses tax revenue.
The IR35 law was supposed to stop them losing tax revenue, and to be honest i even agree with the overall law, they just executed it incorrectly. They put the responsiblity on the company offering the contract, when it should be on the person applying for the contract that has the responsibility to show they're a business and not a disguised employee.
The better way to do it in my opinion is to empower HMRC with more resources to question contractors and show that they are actual businesses and not tax dodging employees.
In the UK, contracting has some very attractive tax implications for highly-paid workers. Our tax service has created a complex set of rules that distinguish a contractor from an employee.
Is that actually the case? As far as I'm aware in the UK at least its not that you're outright forbidden to work as a contractor under conditions that would otherwise be considered employment, you just have to pay tax on that basis rather than pretending you're really an independent company.
There are arguments on both sides eg a Freelance Director of Photography is not going to want to be taxed as an employee.
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