An improper freelance contract occurs when an employment relationship is incorrectly presented as an independent contract. This may happen due to a lack of understanding about the distinctions between employment and freelance arrangements, potentially resulting in non-compliance with statutory employment rights including sick pay, holiday pay, and the National Minimum Wage (NMW). Mistakes can expose businesses to significant risks, including legal penalties and reputational harm.
For businesses, improperly classifying contracts can result in legal disputes, tax liabilities, and damage to their brand credibility. One of the main reasons this issue is important is due to the different tax treatments for employees and freelancers, which carry distinct compliance obligations. Additionally, it is crucial to note that the legal tests for determining employment status and the tax tests for assessing classification are not the same. Complying with both frameworks protects the organisation from costly repercussions and demonstrates ethical business practices. Transparent and legitimate contracts also foster trust and long-term relationships with contractors, which is crucial for operational success. For more information, please access the following resources:
GOV.UK - Employment Status: Offers official guidance on employment rights and classification.
Employment Status Factsheet (ES/FS1): This factsheet provides an overview of employment status and its implications for tax purposes.
The right of substitution is a key indicator of freelance status, allowing freelancers to delegate work to a qualified substitute. This demonstrates their independence and distinguishes them from employees, who are generally required to perform tasks personally. It also highlights their employment status, making it easier to categorise them
Why It’s Important
Independence: Substitution highlights that services are being contracted, not the individual, reinforcing autonomy.
Legal Implications: A lack of substitution rights may indicate an employment relationship, raising risks of misclassification.
Tax Compliance: HMRC views substitution rights as evidence of self-employment under tax rules.
Best Practices for Businesses
Include clear substitution clauses in contracts to support freelance arrangements.
Ensure any approval of substitutes focuses on qualifications and doesn’t undermine the freelancer’s autonomy.
Recognise that substitution shifts responsibility and financial risk to the freelancer.
A legitimate freelance contract typically includes:
Project-Based Work: Clearly defined deliverables, timelines, and outcomes.
Payment Terms: Transparent payment rates and schedules.
Autonomy: Freelancers have control over how, when, and where they work.
No Exclusivity: Freelancers can work for multiple clients simultaneously.
Legal Protections: Provisions addressing intellectual property, confidentiality, and dispute resolution.
Right of Substitution: A clear clause allowing freelancers to delegate work to a qualified substitute, reinforcing their independence. The clause may also state that the business retains the right to approve substitutes but cannot unreasonably withhold approval. This provision demonstrates autonomy and reduces the risk of misclassification of employment.
Key indicators that a freelance contract may not be legitimate include:
Control Over Work:
Fixed working hours, mandatory attendance at meetings, or close supervision.
Little to no control over how tasks are completed.
Dependency:
Exclusivity clauses that prevent the freelancer from taking other clients.
Regular, ongoing tasks rather than project-based work.
Misaligned Pay Structure:
Payment on an hourly, weekly, or monthly basis instead of per project or milestone.
No clarity on how expenses are reimbursed (e.g., travel, equipment).
Pay through payslips instead of being paid through invoices.
Lack of Flexibility:
No option to delegate or subcontract work.
Restrictive clauses that limit the freelancer’s operational freedom.
Employee-Like Benefits:
Provisions for holiday pay, sick leave, or pensions—which are typically not applicable to freelancers.
Ambiguous Scope of Work:
Vague or undefined tasks and deliverables.
No specific end date for the contract.
Absence of Legal Safeguards:
Missing or inadequate clauses on intellectual property, dispute resolution, or confidentiality. A governing law clause that doesn’t align with the jurisdiction of the work.
Business should consider the following tests to assess the classification of freelancers:
Control: Does the employer dictate how and when the work is done?
Mutual Obligation: Is there an expectation that the freelancer must accept work, and the employer must provide it?
Integration: Is the freelancer embedded in the company’s structure, like an employee?
Financial Risk: Does the freelancer bear financial risk, such as providing their own tools or insurance?
Substitution: Can the freelancer send a substitute to complete the work?
When assessing tax status, businesses should also consider these additional tax-specific factors:
IR35 Compliance: Does the working relationship fall within the off-payroll working rules? If so, the freelancer may be treated as an employee for tax purposes. The off-payroll working rules, also known as IR35, are designed to ensure that contractors working through intermediaries, such as personal service companies (PSCs), pay similar taxes to employees if their working arrangements effectively mirror employment. For medium and large businesses, the responsibility to assess employment status lies with the client. If the rules apply, the hiring business must deduct income tax and National Insurance Contributions (NICs) and pay employer NICs on payments made to the contractor. Failure to comply with IR35 can result in backdated taxes, penalties, and interest.
Payment Structure: Are payments made via PAYE, or is the freelancer responsible for their own tax and National Insurance contributions? Independent contractors usually invoice for work and handle their own tax.
Substance Over Form: Does the actual working relationship reflect what is written in the contract? For tax purposes, HMRC prioritizes the reality of the arrangement over its contractual presentation.
Provision of Equipment: Does the freelancer provide their own tools or rely on company-provided resources? Using their own equipment supports self-employment status.
Financial Risk and Profit Opportunity: Can the freelancer incur losses and benefit from profit-making opportunities? Self-employed individuals typically bear financial risks and have potential for profit beyond a fixed fee.
Examine the Terms:
Review the contract for vague or contradictory language.
Look for signs of employee-like terms, such as fixed hours or exclusivity.
Analyse the Working Relationship:
Compare the terms of the contract to the actual work conditions.
Use the Employment Status Checker tool on GOV.UK to assess your classification.
Step-by-Step Guide
Step 1: Visit the Employment Status Checker tool on GOV.UK
Step 2: Answer questions about the working arrangement, including:
Control: Who determines how, when, and where work is done?
Substitution: Can the worker send a substitute?
Financial Risk: Does the worker supply tools or cover expenses?
Step 3: Interpret Results
The tool will provide a result indicating whether the arrangement resembles employment or self-employment. For example, a result of “worker is likely an employee” may suggest a need for further adjustments to the contract.
If terms are unclear, businesses should ensure they provide clarification to freelancers or make adjustments to reflect the genuine nature of the relationship.
Offer revised agreements that accurately capture the working arrangement to avoid potential disputes.
Seek Advice:
Employers can contact ACAS (Advisory, Conciliation and Arbitration Service) for free, confidential advice on employment status, compliance, and best practices for drafting contracts.
Consult with legal professionals specializing in employment law to review contracts and ensure they align with legal and tax obligations.
Engage with industry-specific organizations or business advisory groups for guidance on managing freelance relationships in compliance with sector-specific norms.
If your business identifies a potential misclassification of a freelance contract, here’s how to address it effectively:
Review Contracts and Relationships: Reassess the contract terms and actual working arrangements to ensure they align with legal definitions of self-employment.
Rectify Misclassifications: If a misclassification has occurred, proactively revise the contract and regularise the working relationship to reflect either genuine freelance status or employment.
Engage Legal or Tax Experts: Consult with legal professionals or tax advisors to ensure compliance with employment laws and HMRC regulations.
Notify HMRC When Necessary: If misclassification has tax implications, notify HMRC promptly and take steps to rectify any discrepancies to avoid penalties.
Internal Training: Implement training for managers and HR teams to avoid future misclassification issues.
Film and TV: Freelance costume designers hired for specific projects may be misclassified if they are required to follow detailed company protocols, work fixed hours on-site, or seek regular approvals beyond the agreed scope of work.
Post-Production and Animation: Contracted animators or VFX teams could be treated as employees if required to work on-site or use company software under strict supervision.
Script Development: Writers or script editors working under exclusive agreements or heavy oversight may be wrongly categorized as freelancers instead of temporary staff.
Production Coordination: Coordinators or assistants engaged for short-term projects might face misclassification if they are subject to strict control and integrated into the company’s day-to-day operations.
On-Set Roles (Lighting, Sound, Makeup): Temporary crew members, such as those handling makeup or sound, may be improperly treated as freelancers if expected to follow employee-like schedules or work conditions.
Spotting and avoiding improper freelance contracts is critical for businesses to:
Fair Treatment for Freelancers: Protection of rights and earnings.
Compliance for Employers: Avoidance of legal disputes and penalties.
Healthy Work Relationships: Trust and transparency between parties.
A genuine freelance contract benefits everyone involved, fostering a professional and fair working environment. If you suspect a contract may be improper, act early to protect your rights and avoid legal action.
Note: Material on this platform is not legal advice but we’re here to point you in the right direction if needed.