With the growth of a business will come the need for more people to service the growing number of clients and customers.
When it comes to employees, a plethora of employment laws needs to be considered (especially once the Employment Rights Bill becomes law later in 2025), but the tax consequences also need to be considered.
An Employee?
The first and most important question is whether the individual hired is actually an employee, as opposed to a contractor. If they are an employee, the employer has to operate a PAYE scheme and pay the income tax and National Insurance contributions (NICs) on the salary to HMRC; indeed NICs are the major distinction between taking on employees and engaging contractors – the employer is liable to secondary NIC’s at 15%, a significant cost and essentially a tax on having employees; however, when engaging contractors, no PAYE need be operated nor are any secondary NICs due.
In addition, most employees generally have to be members of a pension scheme to which their employer contributes. The incentive to call a worker a contractor rather than an employee is therefore pretty obvious, and the question as to someone’s employment status has been the subject of court cases over several decades.
Trying to disguise employment with the use of an intermediary (usually a limited company) and a contractual arrangement has been addressed for around the last 25 years via ‘IR35’ rules (known as the ‘off-payroll’ rules since 2020), which deem a ‘contractor’ as an employee if they have the hallmarks of an employee – now regarded as being: control, mutuality of obligation (i.e., a duty to provide work and the corresponding duty to do it) and whether the terms of the contract are consistent with a contract for service (i.e., employment) or contract for services (i.e., a contractor). This three-pronged test stems from the case Ready Mix Concrete v Minister of Pensions QB 1967 which has been tempered over the years by cases such as HMRC v Atholl House [2022] EWCA Civ 501 and HMRC v PGMOL [2024] UKSC 29. Whilst the off-payroll rules only apply where there is an intermediary, these employment tests can apply to an individual whether or not there is an intermediary.
It may come to pass that a senior employee (or potentially even a contractor) is so indispensable to the business that a mere salary or fee is not enough; only a stake in the business will stop them from leaving. However, bringing someone outside your family or close friend circle can always be a bit risky; if the business is a partnership, joint and several liability means that a business owner is tied to that person; a shareholder is an integral part of the business, too, though there is at least the veil of incorporation to isolate much of the risk.
Making a gift of shares will usually result in an income tax charge on the employee, depending on how much they pay for the shares; share options may be considered a safe option as underlying shares are not given upfront, and approved share schemes such as enterprise management incentives or company share option plan will give the employee greater incentives too.
Salary Sacrifice and Benefits-in-Kind
‘Optional remuneration arrangements’ came into effect from April 2017 – prior to that, ‘salary sacrifice’ was an effective way of giving an employee value whilst saving income tax and NICs by reducing salary in return for a benefit-in-kind (whose taxable value is lower than the sacrificed salary). From 2021, income tax is payable on the lower of the value of the benefit or the salary sacrificed unless the benefits are pension contributions, pensions advice, childcare provision or cycle to work bicycles and equipment. However, these rules do not apply if the benefit is provided anyway and there is no reduction in salary or choice to be made as to salary or benefit.
Practical Tip
If someone is being taken on as a contractor, make sure the actual working relationship is one of services, not for service. Otherwise, HMRC might deem that person an employee and demand a hefty secondary NICs bill!