Increased hiring resources and role creation for temporary workers and freelancers can be key to growth for many large enterprises, but if not properly managed, the business could find itself at risk of breaching employment regulations and face financial consequences. From construction and logistics to healthcare and retail, all industries are affected by misclassification regulations.
In the UK, penalties enforced by HMRC for liability over a lack of withholding tax can make up 100% of the amounts due, depending on the severity of the infringement. Navigating the UK employment status and rights to understand the risks associated with staff and independent contractor misclassification is no easy feat. Once this is conquered, achieving and maintaining compliance becomes yet another prominent challenge.
What are the risks that can occur when misclassifying workers and how can businesses avoid falling foul of potential fines?
Financial and ethical consequences
Incorrectly classifying workers in the company directory can lead to an array of financial implications, which can damage the cash flow of the firm. These include:
- Delayed wage, overtime and benefit payments
- Backdated tax and National Insurance payments
- Fines issued by regulators
- Legal fees following action taken by underpaid staff
Other consequences outside financial implications include lost wages, damaged staff morale, loss of talent and unfair competition when it comes to cutting costs. With many industries proving more competitive than ever amidst growing tech innovations, misclassifying workers is not worth these risks.
Confusion over IR35 still exists
The IR35 regulation for UK freelance workers was introduced in 2020 to help prevent business tax evasion occurring as a result of misclassification. Impacting staff not documented on the company payroll, this legislation orders contractors to pay the same amount of income tax and National Insurance as an employee.
Breaching the regulation can lead to millions of pounds in fines being ordered. Notably, a government body was recently fined £36 million for misclassifying staff, resulting in back-dated taxes.
However, a recent report from the Public Accounts Committee (PAC) – responsible for overseeing government expenditures – has accused the rulings of being too complex, stating that businesses are finding hiring freelancers too risky from a compliance standpoint. The report also concluded that the regulation was not sufficiently deterring misclassification.
The global risk of misclassification
Worker misclassification is not just a problem in the UK. Regulators across the world are cracking down on the staff exploitation and tax avoidance involved. For example:
- In the United States, corporations including FedEx and Microsoft have been found liable for misclassified staff over the last 25 years, having to pay settlements in the millions of dollars ($97 million for Microsoft following an eight-year legal battle in 2000; and $500 million in the case of FedEx in a 2015 lawsuit).
- In the European Union, the EU Court of Justice increased scrutiny on firms in 2017, by permitting misclassified staff to claim back holiday pay dating back to 1996.
- In Australia, the High Court of Australia oversaw a 2022 ruling declaring that the documented terms of all contracts would from then on be the primary factor in determining misclassification, having previously gone by a ‘multi-factorial test’ of business relationships as a rule.
How to overcome the pitfalls
To ensure that your business stays compliant with worker classification legislation and mitigate risks, you must do the following:
- Thoroughly audit your current payroll documentation protocols, and adjust where necessary
- Carefully examine the current guidance and labour laws, as well as keeping an eye out for any changes
- Implement clear policies for taking on independent contractors and freelance workers
- Consider partnering with a workforce solution and compliance provider
How a workforce compliance provider can help
Seeking expertise from a globally operating workforce solution and compliance provider can keep your business leaders clearly informed about legal developments pertaining to worker classification, in the UK and further afield.
Employee of Record (EOR) and Agent of Record (AOR) services provide a framework for properly determining how each member of staff should be classified in the system, and how to engage accordingly.
Taking this proactive step can keep you properly informed, as well as reducing strain on hiring and retention processes, leaving you free to focus better on core business activities that bolster your bottom line – rather than damage it.
