Stats from Upwork states that 12% of the workforce have started freelancing from 2020 and 58% are more likely to shift to contingent work in the future. This era thus witnesses a surge in the rise of contractors and other contingent workers. Thanks to the acquaintance with remote work, people opt for self-employment and pursue different roles they are interested in without being tied up to just one company or job role.
The aftermath of this surge is the onset of hidden or disguised employment. Let us explain the true meaning of disguised employment and why it is important to stay aware and cautious.
So, What is Disguised Employment?
Disguised employment is when workers performing employee duties are misclassified as self-employed or contractors. There exists an employer-employee relationship between them. It is also referred to as hidden employment.
It arises due to misclassification of employees- the governments condemn and discourage such acts as the employers fail to include and regulate the income taxes and PAYE for these deemed employees.
A clear definition of who a core employee is will throw light on the differences both types of employees have.
Who is an Employee?
The term employee refers to the individuals who are given full-time employment in a firm.
They hold core positions and roles in the company and come under their payroll. They are eligible to avail of the additional perks offered by employers. All employee rights and protections apply to them.
Employee vs. Contractors
As per the above definition for an employee, the individuals working in a company but do not abide by any of the above are called contractors.
They are self-employed, meaning, they do not work for one specific firm. They are not salaried and aren’t eligible for the fringe benefits or rights a regular employee has.
More often than not, the classification gets blurred, and the contractors are treated like regular employees, causing disguised employment.
How is Disguised Employment Different from Regular Employment?
The differences can be viewed from two perspectives.
If you are a contractor, the company isn’t your employer but your client. You’re the boss of you. This gives you the leverage to control your work.
You help your client with specific projects or tasks, and you do it at your own pace and methods. You have your own work schedule, decide your work timings, etc
However, in disguised employment, this doesn’t happen. When the classification is muddled, your clients tend to act as your employers. You might have:
- Dedicated working hours
- Reporting duties
- Have the employer tell you what to do, when to do and how to do the given task
- You might be asked to work from their offices
You might be their employee, without availing any benefits the firm offers. This is advantageous as they do not have to make National Insurance Contributions (NICs). They also need not provide fringe benefits such as paid leaves, parental leaves, hikes, profit-sharing plans.
If you’re an employer, you most probably fell into the misclassification whirlwind. You should be well aware of the above differences between contractors and employees and treat them accordingly.
How can Disguised Employment be Identified?
Disguised employment has ruffled way too many feathers in tax regulation norms. Governments brought in new acts and guidelines to deal with the challenges posed by hidden employment.
The tax authority of the UK government, HMRC (Her Majesty’s Revenue Customs) introduced the IR35 legislation. It is an anti-avoidance tax legislation act designed to combat tax avoidance by contractors due to disguised employment.
Such contractors are called “deemed employees”. If found guilty, they undergo an IR35 investigation. The investigation checks for the following:
A client cannot exercise control over the contractor like an employer. They cannot direct where, when, and how the work is to be completed. If the contractor lets their client control their work, then they effectively become a disguised employee.
A contractor can have substitutes, meaning if unavailable, they can ask someone else to complete the tasks on their behalf. Their client can neither demand exclusivity nor oppose such replacements.
If they do not allow such substitutions, then that simply means they treat them as their employee, and the contractor becomes their “deemed employee”.
3. Mutuality of Obligation (MOO)
The client-contractor relationship is analyzed here. If the contractor expects their client company to offer work to them and they, in turn, expect the contractor to keep working for their company, then their relationship has transformed into an employer-employee (disguised) relationship.
These three conditions are analyzed during the IR35 investigation to understand their mutual relationship and employment status. If found guilty, the contractor is liable to penalties and other legal complexities.
Why is Identification of Disguised Employment Essential?
Time, money, and manpower are our lifelines. We wouldn't want to squander them off. Complying with the prevailing laws and regulations is the best way to save them.
However, if found guilty, everyone involved is subjected to the IR35 investigation. This has the potential to burn out all the above lifelines.
The investigation deems an in-depth analysis of the employer-employee relationship through activities performed by the employee, your contract terms and hence is time-consuming.
Imagine the cost acquired by both the client and the contractor. They will have to deal with:
- NIC and employment tax contribution penalties
- Arrear payments on the employment taxes,
- Fees for the attorneys involved
Besides the direct expenses, during the investigation, they cannot resume work. This might cause further loss of money.
It only seems wise to dodge these challenges by drafting impregnable contracts that comply with IR35. Also, ensure that your terms and conditions are clear and well-informed, before sealing the deal.
Here are a few tips to help you stay compliant with the IR35 contract.
Your contract can include but is not limited to:
- The duties of both the client and the contractor
- The extent of their controls
- Stay non-obligated to each other
- Provide the contractor more control over their work
- Clearly state their expectations
Thus, staying compliant with the IR35 tax legislation plays a major role in the smooth running of employment partnerships.
To give you more reasons, let us take a leap and understand the measures each country takes to curb hidden employment.
The Risks and Penalties for Disguised Employment
The legislations of different countries have different rules. Each country follows its own system to handle disguised employment.
Disguised employment in the US
Disguised employment is deemed a serious issue in the US. The US Internal Revenue Service (IRS) is responsible for handling worker misclassification and disguised employment.
In contrast to the IR35, the IRS holds the employer responsible for disguised employment. This makes the employer liable for unpaid income, social security, and employment taxes, and legal complexities due to worker misclassification.
The Employee Misclassification Prevention Act 2010 penalizes employers with nearly $5000 fines for each misclassified employee. The Fair Playing Field Act 2013 requires client organizations to give written confirmation of each hired contractor’s tax obligations.
Disguised employment in the UK
As discussed above, IR35 is a set of tax laws as a part of the Finance Act of the UK Tax Authority.
Besides IR35, legislation regulating the intermediaries in the employment arrangement has also been included in the Income-tax Act 2003, and the NICs are similarly integrated into the Social Security Contributions Regulations 2000.
New Off-Payroll rules are also in place to make sure the deemed employees or the intermediaries pay the tax contributions. These new rules introduce a set of tax treatments that require the client firms to assess the contractor’s employment status prior to the contract.
Disguised employment in Singapore
In Singapore, when an independent contractor is deemed to have an employment relationship with a firm, the contractor will be re-classified as an employee. Like the US, the employer is liable and has to deal with the complexities due to the misclassification.
The employer must comply with all the labor laws that protect employees, most of which function retroactively, implicating that they must also pay arrears to the contributions to the Central Provident Fund, Singapore’s comprehensive savings plan for retirement, healthcare, and housing.
Additionally, the arrears would have also acquired interests over the years and adds to the overhead expenses.
The employer must also provide the misclassified employee statutory benefits any usual employee would get. Further, the converted employee can also sue the employer for any damages caused.
Disguised employment in California
The Californian law follows the footsteps of the US government and penalizes employers who misclassify employees as contractors.
The civil penalty ranges between $5000 and $15000 per misclassified employee. If it is found intentional or a regular occurrence, an additional fine of $10,000 to $25,000 is added.
Overall, the employer will face the misclassification penalty, back payments, unpaid wage penalty, waiting-time penalty, court and attorney fees, IRS tax penalties, criminal penalties, and damages cost. A heavy compensation to pay, for sure.
Disguised employment in Germany
Germany does not have custom policies to define a contractor's employment status. However, the German Federal Labor Court, Das Bundesarbeitsgericht, assesses it on a case-by-case basis.
The scope of the contract, the specified terms and conditions are analyzed to identify if the contractor is misclassified.
Disguised Employment in Malaysia
The Malaysian government also doesn’t have definite legislation clauses to distinguish contractors and laws to curb misclassification. They also deal with it on a case-by-case basis. The case history shows that the penalty can go as high as RM180,000, and the employer can be sued by the contractor for damages.
Avoiding Disguised Employment
Hidden employment arises due to incomplete contracts. A namesake contract cobbled together with improper clauses leads to non-compliance and hefty penalties.
To steer clear of such thorny situations, both the employer and the contractor must discuss and put across their expectations from each other clearly. Maintain a transparent partnership.
Your contract must be tailored to encompass all the possible issues that might arise. Leave no room for ambiguity.
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