If I asked you what is a disguised employee, would you know or would you immediately start looking around your office for a member of staff dressed as a penguin or looking shady in dark glasses, a dodgy beard and a baseball cap?

In fact, due to the IR35 Legislation brought in by the HMRC to help assist them with tax avoidance issues, it is important that business owners, their personnel staff and any contractors that work for them on a long term basis, understand exactly what is meant by a “disguised employee”.

So what is a disguised employee?

A “disguised employee” is a contractual worker who fills a permanent position in your company but doesn’t pay the corresponding income tax and National Insurance contributions (NIC) a permanent worker would.

Under the IR35 legislation, a contractual worker will fall under IR35 if:

    • The worker works for a client but does not invoice that client directly for the work carried out, but instead contracts for an intermediary (also known as an Umbrella company).


    • That the worker is employed by an intermediary on behalf of the client, making it easier for the client to dispense with the services of the intermediary more easily then it would be to dispense of the services of the worker directly, it also allows the client to avoid PAYE and NIC issues.


  • The worker has at least a 5% beneficiary interest in the intermediary company, or takes their earnings in the form of a dividend on which NIC isn’t paid.

There have been many complaints that the IR35 legislation is too vague, and that there aren’t enough accountants with a complete enough understanding of how IR35 works, but there are some basic guidelines that you can follow to help you steer clear of the pitfalls.

How can I tell who is likely to be classed as a disguised employee?

The test employed by the HMRC to decide if a worker is actually employed is complex and the results are often uncertain, and to add to the confusion it is possible for an individual to have a different status for tax purposes, then for employment rights. For example, the HMRC may accept that a worker should be taxed on a self-employed basis, but when faced with an employment tribunal, the same worker could be categorised as being entitled to certain employment protections like minimum wage, paid annual leave or sick time.

As previously mentioned, there are some indicators that can help you decide if your workers are likely to be found as disguised employees if they undergo an IR35 investigation. The three main ones include:

    • Control – If you are telling your contracted worker, where, when and how you want the allocated work completed, then they are likely to be considered as employee’s – Contractors that aren’t “disguised employee’s” have the right to decide for themselves where they work, what hours they work, and how they will go about completing the work given to them.


    • Substitution – If for some reason the contractor can not work their hours themselves, they have the right to use a replacement or substitute to complete the work for their client on their behalf – if you as the client, will not allow anyone other then the contractor to work on the project, then that contractor is effectively employed.


  • Mutuality of Obligation (aka MOO): If the Contractor expects work from the client, and the client in turn expects that work to be completed by the contractor then there is seen to be a Mutuality of Obligation, which again, will lead the HMRC to conclude in all likelihood that your contractor is a disguised employee.

Although these are the main three criteria that are looked at, they are just three of a very complex system, and rather then try to fathom it out yourself it may be advisable to seek the aid of a professional.

As mentioned before it can be difficult to identify a local accountant or book-keeper with experience of IR35 contracts, but it is possible – if you ask them if any of their clients have contracted workers, and what their experience is they are normally more then happy to tell you.

If you have no luck with that avenue, then there are companies who have specialist Personnel Managers who have experience in writing contracts that can possibly help you by looking over any potential contracts to ensure you comply with the IR35 Legislation.

Alternatively, you can seek advice from the HMRC, either current employee’s or former Tax Inspectors will be able to advise you on if the contracts are IR35 compliant, if the level of control you are exerting over your contractor is too high, or any other concerns you may have.

There are also several “online tests” available to see if you are IR35 compliant, and many will then give basic advice dependant on the results from the answers you provide.

Why is identifying “Disguised Employee’s” so important?

It is important to identify any possible “disguised employees” as an investigation can take up a lot of time, not to mention manpower and finances if you are forced to undergo one.

Because of the complexity of the system used to identity disguised employment, it is naturally time consuming, and during the duration of the investigation, you may find you have to make yourself, your contractor, and any records available to the investigation, which could cause there to be down time for yourself and you contractor and any other member of admin staff you have delegated to pull the relevant records when asked.

As to how much it could cost financially, that really depends on how much the contract rate is.

Generally speaking the cost will be the additional NIC and Tax contributions that are payable on the deemed salary. There are several online calculators out there that can help you determine how much this is likely to be.

Though there is every chance that it may cost more then that if the HMRC decide that it was a conscious attempt to try and defraud the tax office and go the prosecution route.

So as you can see, it is a good idea to make sure any contracts are water tight and get the professional advice that will help make sure you are covered if there is ever any dispute regarding hidden or disguised employment.