When is a contract worker an employee?

As the two worlds of employment and tax status collide, it could mean
problems for employers and individuals

Two recent cases illustrate the practical and legal difficulties in
determining whether an individual is an ’employee’ for the purposes of the
appropriate tax regime and also whether they may benefit from employment
protection rights.

This is significant to businesses which have traditionally sourced skilled
workers through personal service companies; an arrangement common in IT,
engineering, telecoms and management and business consulting.

From a tax angle the Inland Revenue will wish for these individuals to be
’employees’ but the contractors often want the arrangement to be one of self-employment.
From an employment rights angle, however, contractors such as Mr O’Murphy may
argue the opposite in order to have employment rights protection.


Professional Contractors’ Group v Inland Revenue was recently handed down by
the Court of Appeal. It was brought as a challenge to the legality of the IR35.

These are an anti-avoidance measure which require consultants to be treated
as employees under Schedule E "where the circumstances are such that, if
the services were provided under a contract between the client and the worker,
the worker would be regarded for income tax purposes as an employee of the

This has caused consternation not only to the contractors who view IR35 as
anti-competitive, but also to the companies buying in their services who have
been concerned that IR35 may also compel them to treat such individuals as
employees in respect of general employment rights.

The Court of Appeal has rejected the PCG’s appeal and refused to strike IR35
down. The Inland Revenue will therefore continue to seek to apply it to
maximise the collection of tax through the PAYE system.

Hewlett Packard Ltd v O’Murphy [2002] IRLR 4

O’Murphy was a computer specialist who supplied his services for six years
to Hewlett Packard (HP) through a service company which, in turn, entered into
a contract with an employment agency contracted to HP. When he claimed unfair
dismissal against HP, the Tribunal found that factors such as the control
exercised by HP and his integration into its business were sufficient to
establish he was an employee of HP.

The EAT, however, disagreed with this analysis and found a critical factor
in O’Murphy’s case was the intervention of an employment agency.

This meant there was no ‘contractual nexus’ between O’Murphy and HP, making
it impossible in law for him to be its employee.

This puts individuals such as O’Murphy in the invidious position of
potentially being treated as employees for tax purposes but self-employed for
employment law purposes.

Key points

– Ensure no mutuality of obligation exists requiring the service company to
perform additional services

– The engagement should relate to completion of a particular project and be
subject to payment of a fixed sum on completion

– The consultant should provide services to a number of clients and the
service company should reserve the right not to have to provide a particular

– The insertion of an employment agency between the client and the service
company may defeat any argument on the basis that an individual is considered
an employee for employment protection purposes

By Sarah Lamont, a partner at Bevan Ashford solicitors

Comments are closed.