Make sure you know the difference - otherwise it could cost you time and money later.

If you thought the difference between being self employed and employed was clear-cut, you'd be wrong. The lines between the two can be very blurred when it comes to where and how you work. Yet it's vital to know so you don't incur the wrath of the tax man.

The classic definitions

"In essence a contract of service is given to an employee whereas the self-employed have a contract for services."

An employee is required to report for work at a designated place and time, probably for an annual rate of remuneration. As an employee he or she would be entitled to sick and holiday pay. The employer would operate PAYE on their salary, and pay tax and National Insurance deductions for that salary.

A self-employed person on the other hand, is running a business of providing their services to carry out a contract on perhaps an hourly or daily rate for a client. How or where the services are provided is largely immaterial. They're responsible for their own tax and National Insurance and don't receive any benefits like holiday or sick pay.

In essence a contract for service is given to an employee, whereas the self-employed person has a contract for services. These contracts can be written, verbal or implied.

The acid test

If for example you're a contract or freelance worker reporting to one employer for fixed periods of say six months at a time, you're entitled to wonder what your position is. Some of the tests to ascertain where you fit in, include:

1. Are you subject to the control of the employer as to what you do, and when and how you do it?

2. Does the employer have the right to suspend or dismiss you as an "employee"?

3. Are you as the "employee", part and parcel of the employer's business?

4. Do you supply your own tools, equipment or materials?

5. Is the question of your annual profit or loss of any concern to the employer?

6. Do mistakes have to be rectified in your own time?

A case in point

Take the example of fashion designer Claire. She has a contract with a leading high street retailer to provide a winter collection. She spends two months working on the designs and presents the results to the shop, having worked on the designs on her own premises, possibly with the help of others.

If the retailer likes what she has presented, it places orders and agrees the prices. If it doesn't like her work, she may not receive any payment, but she's free to take her work to another high street shop. She is self-employed.

In contrast Tracey also has a contract to provide a similar collection. She spends three months on the work and is paid for her time. All her equipment is provided on the retailer's premises, which she has signed the contract with. She is clearly an employee. It has no bearing on her financial status if the designs are accepted.

The employer's obligation

The onus of proof is on the employer to define your status. If it turns out you had employee status and the company failed to operate PAYE, it would be called on to pay the appropriate tax and NI contributions which should have been deducted from the employee, without being able to ask you to pay the money back. It may also be fined for not getting your status right.

In terms of expenses there are two distinct differences between being employed and self employed. For the self-employed the expenses allowed are those that are "incurred wholly and exclusively for business purposes". For an employee the phrase is extended and includes the word necessarily: that is, expenses "incurred wholly exclusively and necessarily for business purposes". So for employees allowable expenses operate under a far more restrictive regime.

National Insurance