Adding to Your Team? Employee or Consultant?

Short and long-term analysis for fund managers

Originally published in the June | July 2015 issue

Many fund managers believe that it is better to hire new staff as consultants rather than employees. But consultants aren’t always cheaper than employees, and the undoubted advantage of flexibility may be offset by other factors. This Insight assesses the relative merits of consultant and employee status.

Employee or consultant?
For many fund managers, it is axiomatic that there is an advantage to on-boarding additional staff as consultants rather than as full-blown employees, at least initially. It is widely believed that consultancy arrangements invariably provide greater flexibility, less administration and expense and fewer burdens than employment agreements.

But this is a two-dimensional understanding of the relative merits of employees and consultants and the legal aspects of the relationship between a business and its personnel. Consultancy arrangements certainly do have their place in the industry. Consultants allow a business to access particular expertise that it does not have within its existing payroll, without needing to spend time and money on the recruitment or training of employees. In certain circumstances, however, classifying a staff member as a consultant when the arrangement more accurately reflects that of an employee leaves the business open to unnecessary and sometimes costly risks.

There is no one-size-fits-all, so it is important to tailor the arrangement for the particulars of the relationship in question. When a fund manager on-boards new staff, they should consider what each new role demands and how it is set up. For example, is it for a fixed time period or a specific project, or does management want someone to help build up and become an integral part of the business? Will the worker be supervised or largely independent? Will they work in the office or work offsite to their own schedule?

“Lipstick on a pig”
The complexity of the law surrounding employee status means it canbe difficult to say with certainty whether an engagement is genuinely a consultancy. No matter how the business labels a member of staff, HMRC (or an employment tribunal) can nonetheless deem him to be an employee for tax (or employment law) purposes.

The key factors that both HMRC and the employment tribunal would consider when determining an individual worker’s status for tax or employment law are:

  • Personal services – is the individual required to personally turn up for work and perform the services himself?
  • Mutuality of obligation – is the employer obliged to offer work?
  • Control – how much control does the employer  have over the individual’s day-to-day tasks?

Note that a person’s tax status and his employment status are not necessarily correlated; an individual can be deemed an “employee” for tax purposes but not for employment law purposes, and vice versa. To make things more complicated, HMRC and the employment tribunals may also differ according to the weight they afford to these (and other) indicative factors when determining tax/employment status.

While no one factor will be decisive on its own, the greater the degree of personal responsibility and independence that the individual assumes in the relationship, the more likely it is that they are engaged as a consultant rather than an employee. If a business misclassifies an employee as a consultant from the outset, there will be tax and other costs.

All other things remaining equal, it is likely that hiring someone as an employee will cost more in tax, for both the business and the individual, than hiring him as a consultant. The employer is liable to pay National Insurance Contributions (NICs) for each employee.

In contrast, employer NICs are not payable for a consultant. Moreover, the onus of paying tax is often shifted contractually from the business to the consultant. The consultant is usually responsible for registering for VAT and making VAT payments to HMRC. Therefore, it is always advisable that a tax indemnity is obtained from the consultant protecting the business from unexpected recovery by HMRC for unpaid taxes.

If a ‘consultant’ is later determined by HMRC to have an employee status, the business will be retrospectively liable for under-deducted tax, employer’s NICs, penalties and interest – which would, in retrospect, make an employment contract cheaper in the first place!

Costs and benefits
Aside from tax, costs associated with employees can include various benefits such as pension contributions and private medical care as well as statutory rights relating to, for example, redundancy costs, sick leave and holiday pay as well as office space and equipment.

But consultants aren’t always going to be cheaper. Consultants are frequently paid a daily or hourly rate, which, when annualized on a like-for-like basis, often turns out to be more expensive than a comparable employee’s fixed annual salary. Also, if a consultant in practice works in much the same way as an employee, their associated costs will be very similar to those of an equivalent employee, e.g., use of office space and equipment. Depending on the terms of the consultancy agreement, consultants may also be entitled to statutory sick pay, and in some instances may be subject to auto-enrolment in a pension scheme.

Non-disclosure, non-compete, etc.
In the fund management business it is likely that, whatever role an individual fills, they will be privy to a high level of confidential information and in some instances may have direct access to current and potential investors, clients and suppliers. Unlike employees, consultants are generally under no implied obligation of confidentiality,so express confidentiality provisions must be inserted into a consultancy agreement.

It is also increasingly standard practice for a business to impose onerous restrictive covenants in consultancy agreements, especially non-compete and sometimes non-solicitation, but do consult your legal advisers – as there is a real risk that including these clauses will be construed by an employment tribunal as indicative of employee status.

Employer liability
Employers are vicariously liable for the acts of their employees. There is a tendency to assume this means increased burden and cost vis-à-vis a consultant. However, in practice it may not differ much. A professional consultant would ordinarily seek to exclude or limit his liability. Vicarious liability can exist outside the employer-employee relationship, too. The law also provides for “non-delegable duties”, for which the business will remain liable even if they are undertaken by a consultant.

Internal policies and procedures    
Employers are required by law to have drafted and implemented various policies and procedures. Older or larger businesses will almost certainly already have these in place, so there will probably be no extra administrative burden of hiring an employee versus a consultant. But a start-up manager would have to put everything in place from scratch for what may be its first few hires.

Furthermore some policies are required for all workers regardless of status, e.g., Health and Safety. Businesses will often have blanket policies in place that are intended to apply to all those who work for the business regardless of the type of contract in place. In this case a consultant will still need to abide by the policies, so the practicalities are unchanged from that of an employee.

And the winner is?
Consultancy is a valuable commercial tool for any business; it allows the business to access a particular skill or expertise that it does not have within its existing workforce without needing to spend time recruiting or training employees. The less a consultant’s day-to-day role is like that of an employee, the greater the likely savings. However, the costs of mischaracterising the relationship are high. Therefore, as a general rule, if a worker looks and acts like an employee, it is likely that they will be deemed an employee no matter how you dress it up!

Fund managers should also have an eye on the long run. A consultant contracting through a limited company will enjoy personal tax benefits, but prospective hires may prefer the greater job security, regular income and statutory employment protections that are associated with employment. The market for talent is hyper-competitive. Therefore it may be necessary to consider which arrangement best suits both the individual and the long-term interests of the business.

Charlene Cowen is Head of People and Wellbeing and a Senior Associate at MJ Hudson, a law firm providing legal advice to the alternative assets industry. Cowen has experience on various aspects of private equity transactions, including fund formation, secondaries and corporate/M&A transactions. She predominantly focuses on employment, partnership and other advisory work for investment firms and their portfolio companies.

Kelly O'Brien is a trainee solicitor at MJ Hudson and works on a variety of private equity transactions.