The Inland Revenue has recently succeeded in claiming that some suppliers of technical services, who are sole traders or "freelancers", are in fact temporary or part time employees. As an employee, income tax and NI contributions have to be deducted at source by the employer, who also has to pay Employers National Insurance.

Most companies within our industry need to be able to sub-contract certain parts of their own contracts to other specialist sub contractors, or suppliers. We do not want to have to find people who are willing to become temporary or part-time employees to fulfill these requirements, in place of sub contracting these services.

As a freelancer you have always been regarded as a business in your own right but unfortunately, it does not matter how you are "regarded" anymore: the criteria defining self employment are set out in law and clarified by court precedent. To make it more difficult, a person may be self-employed on one contract and have overriding employee type characteristics on another.

In the light of potential increased interest from the Inland Revenue it is now important for most companies to clarify this relationship and to take any necessary steps to ensure that companies are applying the correct tax treatment to any business transaction between them and a sole trader.

The means that a company must now prove that it is genuinely sub-contracting services to a business in it's own right and not, in any circumstances, engaging a temporary employee.

The agreement that you will probably have signed with most of the companies that you subcontract to will have covered the criteria at the time but it appears that now these agreements or declarations do not provide 100% assurance that a supplier who is a sole trader cannot be deemed to be an employee by the Inland Revenue. In order to clarify this 100%, to the advantage of both parties there, appear to be three options:

Convert your business into a limited company or partnership

Where possible it is advisable for all sub contractors who are sole traders to turn their businesses into limited companies or partnerships. The advice is that there are very few circumstances where a limited company or a partnership can be treated as an employee.

For many individuals there are now potential tax advantages in incorporating as a company. Incentives have been launched to encourage sole-traders to incorporate, by offering a tax-free rate for the first £10k of profit that a business makes. A sole trader could potentially become a director and owner of his own technical services company, pay himself a small salary under PAYE and the remaining profit that the business makes could be paid as a dividend. This is very much down to individual circumstance but may well be very advantageous. Please talk to your accountant or tax advisor about this.

A limited company also provides the benefit of limited liability to its shareholders (owners). That is, in the instance of a negligence or insolvency claim, the claim is with the company and not the individuals who own the business.

The costs of incorporating and running a limited company are not great for a small business and once established, should not really cost any more in accounting terms than preparing the accounts of a sole trader.

A partnership would work in the same way and be subject to similar conditions.

Continue as a sole trader but make absolutely sure that all criteria are met

Where incorporation is impossible or undesirable for the sub contractor, each company business transaction with that sub contractor will need to be checked against the criteria for 'true self-employment' to ensure that you can be engaged as a sub contractor not as an employee. Criteria notes are below.

Continue as a sole trader and do nothing about the above

Where neither of the above options are possible or desirable, a contract of employment must be issued and standard deductions of income tax and national insurance must be deducted.

What are the criteria for true self employment?
(For definitive information, go to www.inlandrevenue.gov.uk and enter IR56 and/or IR35 in the search field.)

In summary and in the context of the nature of services that you offer, there seem to be two points to consider:

• what are the nature of the services that are being contracted and what is the basis of the contract?
• who is the company contracting them to?

Obligation to accept a contract
If you are a true sub-contractor in business in your own right, you are not obliged to accept a contract that is offered to you. It is up to you to make a decision whether the contract will be sufficiently profitable for you to wish to accept it. You, as a business, must weigh up what it is going to cost to provide the services, by way of getting there, getting your tools and equipment there, providing any other items required to complete the contract etc. The company will make clear what services are required together with any scheduling details and deadlines. You will provide a quotation which may or may not be accepted.

Can you make a loss on a contract
The acid test that the Inland Revenue applies to the validity of sub-contractors is "is it possible to make a loss on a contract as well as a profit? Does the individual risk his own money in the course of the business and take a true business risk?" The answer to this has to be yes (and always has been yes). By way of example: you are performing contracted services on behalf of your business and you are taken ill. It is your responsibility to provide a replacement, organise their travel and arrange for your own travel away from site. In this instance your business might make a loss on a particular contract but you are accepting this as a normal and true business risk.

Do you have to provide the services personally?
One of the other tests is whether you as an individual are obliged to personally provide the contracted services. The answer to this is no and has always been no. You are at liberty to provide whatever competent persons you wish, to fulfill the contract that your business has been awarded.

Correcting defective work
A further demonstration of accepting business risk is that you agree to correct any unsatisfactory or defective work at your own cost and in your own time.

Personal protective equipment, tools, equipment etc.
You are also responsible for your own Personal Protective Equipment, Public Liability Insurance, specialist tools, test equipment, harness / rope access equipment etc., to complete the contract. This also applies to training, licenses etc. You may also be asked to provide your own risk assessments and method statements, relating to the services that you have been contracted to supply.

Quotations, administration and paperwork and other business practices
In addition to the criteria, it is important to demonstrate that the sub contractor's business acts as any other business acts; this means proper quotations, letterheads, printed invoices.

You will in the future be asked to provide a quotation. You may need to demonstrate and generate a business transaction as follows:

• The Company will detail the contract to you (initial enquiry).
• You quote the company a price for completing the work
• The Company accepts your quotation, even if it is a verbal quotation (by sending you a purchase order)
• You complete the sub contracted project and submit an invoice for payment.

Per diem expenses and travel allowances that form part of a particular contract must be included within the price agreed for the project. The point here is that although the company and you may both use a daily rate for labour / food / transport to calculate and establish a contract value – it is up to you to quote a single figure to the company to complete the services that have been detailed. Contracts will therefore need to be awarded on a project specific basis and will not take the form of a "daily rate x number of days plus travel and per diems".

What it actually costs your business to complete the services is up to you to estimate before you accept a contract and is not something that the company can reimburse directly. At the point that the Company pay the actual travel expenses / petrol etc., of a contractor, they would then have to be treated as an employee.

For any further information, please have a look at the PSA website at www.psa.org.uk or have a chat with your accountant or tax advisor.