The Ins and Outs of Working as a Sole Trader and Limited Company in the Beauty Industry
Joanne Harris, Head of Technical, Compliance and Payroll at SJD Accountancy, which specialises in tax and accountancy services for Sole Traders, Limited Company owners and small businesses sits down with PBL Magazine to share expert advice for salon owners working with Sole Traders and Limited Companies.
The findings of a report released at the end of 2021 into employment in the personal care sector highlighted how the number of self-employed workers continues to grow. That ongoing increase means self-employed workers now represent about two-thirds of the industry, despite the challenges many felt as a result of the pandemic and various lockdown restrictions.
Making the decision to become a self-employed beautician, hairdresser or nail technician can have many benefits over working as an employee in a salon. They can include more flexible working hours, more choice over clients and greater take-home pay. Typically, setting up as a Sole Trader is the easiest option, but there are those who choose to create their own Limited Company instead.
For salon owners who often have set up their own limited company, linking up with other self-employed workers can be an appealing option too, particularly those who may not want to manage a number of full-time staff. As well as the reduced admin, things such as National Insurance contributions, holiday pay and sick pay do not have to be factored in. It’s crucial that the nature of each working relationship is managed properly in the eyes of HMRC though, and laws around employment rights must be carefully considered.
In this article we take a closer look at some of the potential issues that could arise if careful consideration is not given to the working relationship between a salon owner and other self-employed workers. But first, it’s important to establish some of the differences between a Sole Trader and a Limited Company.
What is a Sole Trader?
A Sole Trader is a self-employed person who owns and runs their own business as an individual.
Sole Traders need to keep records of their income and expenses and then file a Self-Assessment Tax Return (SATR) annually. This will calculate the income earned and the taxes due in the year. Once the SATR has been submitted to HMRC, tax liabilities will need to be paid at the required time.
Income Tax is paid on profit earned, irrelevant of whether all the profit has been taken in the tax year. Class 2 and Class 4 NI contributions also need to be paid. For those earning around or below the basic rate tax threshold of £50,270 (22/23) then working as a Sole Trader may be the most tax-efficient option as there is no company tax to pay.
What is a Limited Company?
A Limited Company is a type of business structure whereby a company is considered a legally distinct body. When an individual decides to set up as a limited company and has no initial intention of hiring employees, this is known as a Personal Service Company (PSC) and that person is usually the only shareholder and company director of the business.
Setting up as a Limited Company can offer more opportunities for growth, tax planning and commercial credibility. Higher earners will need to pay Corporation Tax at 19% (current rate), and further personal Income/Dividend tax when withdrawing the funds. There is also the opportunity to bring on employees in the future, if desired. Limited Companies generally provide a better return on earnings as profits rise over the higher rate tax bracket of £50,270, however you should also consider other reasons, such as commercial or personal circumstances.
Can Limited Companies and Sole Traders work together?
It’s very common for Sole Traders and Limited Companies to work together in different capacities and in different sectors. Often it will be the case that a larger business has a limited company structure and engages the services of sole traders. In the personal care market, the scenarios can often be a salon owner being a Limited Company, with self-employed beauticians working in their salon, many of which will be set up as a Sole Trader. Salon owners that are a Limited Company can benefit from renting space to Sole Traders, as they are effectively contributing to the bills, optimising dead space and bringing in more clients that may be interested in other treatments. This creates a mutually beneficial relationship between the salon owner and other professionals, allowing both to retain their individuality but support each other.
Although the pandemic encouraged many self-employed workers in the sector to convert spaces at home to ply their trade, there are still lots that choose to rent a chair from a salon, using a percentage agreement, a fixed rent rate or sometimes a combination of both of these. In some cases, people also work from home and rent a chair as a way to boost their total income.
This is perfectly fine to do, but there are some rules to be aware of when it comes to the nature of the working relationship between a salon owner and a self-employed worker. One of the potential pitfalls is known as IR35.
How does IR35 apply to the personal care market?
IR35 or to use its full name - ‘off-payroll working rules’ – is legislation from HMRC designed to prevent ‘disguised employment’ across the UK. The rules are intended to make sure that self-employed workers who would have been an employee if they were providing their services directly, pay the same Income Tax and National Insurance contributions as employees.
IR35 doesn’t apply to Sole Traders, but there are rules around designation of employment status –closely tied to IR35 – which affect everyone who provides a service to another business. We’ll go into that more later in this article.
Back to IR35 for now, the rules do apply to Limited Companies, so Salon Owners working with PSCs need to be aware of this. IR35 also applies to other company set ups, such as partnerships and individuals, but we’ll focus on PSCs as this is more common in the personal care market.
Under the current laws, it’s important to show that the working relationship between two parties such as a salon owner and a hairdresser who is a PSC, is not disguised employment.
Reforms to the rules around IR35
New rules for off-payroll working in the private sector came into force from 6 April 2021, putting the onus on large and medium-sized private-sector businesses to determine the employment status of the self-employed workers they work with. Previously, it was up to the worker to determine their status and protect themselves against the possibility of a HMRC claim.
However, these new rules have not been extended to small business in the UK. A business will always be small for its first financial year (of trading) and the definition of 'small' is taken from the Companies Act 2006, which means a business must meet two or more of the following:
Have an annual turnover not exceeding £10.2m
Have a balance sheet total not more than £5.1m
Have an average of no more than 50 employees for the company’s financial year
If you are a salon owner and you meet at least two of the above, then you will be classed as a small business in the eyes of HMRC. This is important as it means the responsibility for determining employment status sits with the PSCs you may be working with.
There are currently no confirmed plans to extend the rules to small businesses and flip the responsibility, but this is an area to watch closely as this may change.
How to determine IR35 status
To be ‘inside of IR35’ means the working relationship is effectively one of disguised or ‘deemed employment’ and PSC must pay Income Tax and National Insurance on their income.
PSCs who are genuinely in business of their own account and receive an accurate and fair assessment can continue to work ‘outside of IR35’.
There are some key principles that will determine IR35 status, which are:
Supervision, Direction and Control: What degree of supervision, direction and control does the salon owner have over what, how, when and where PSCs complete their day-to-day work?
Substitution: Is the PSC required to carry out the work, or can someone be sent in their place?
Mutuality of obligation: Are you obliged to offer the PSC work, and are they obliged to accept it?
To determine whether the working relationship is inside or outside of IR35, it requires looking at the written contracts between the parties and crucially, the actual working practices. When considering IR35 status, it is important to establish a hypothetical contract that reflects the true nature of the relationship between the PSC and you as a salon owner.
If a medium or large salon owner is working with PSCs, IR35 may well be their responsibility. If it is a small salon owner, it becomes the PSC’s responsibility. However, both must consider whether they treat workers more as employees, irrelevant of them being a Sole Trader or Limited Company themselves.
To help in determining a contractor’s IR35 status, the government recommends using its Check Employment Status for Tax (CEST) tool.
One note of caution is that the tool has been found to have flaws after some high-profile court cases, and also other government departments being let down by the tool and incurring tax bills from HMRC for incorrectly identifying IR35 status after using the tool. If in doubt, it's always advisable to speak to a qualified professional or an accountant on IR35 compliance.
Once the IR35 status decision is made, it should be detailed in a Status Determination Statement (SDS) – a written statement put together stating the employment status of a PSC following an IR35 assessment conducted with reasonable care.
Designation of employment status - for Sole Traders and PSCs
Now that we’ve established how IR35 works for PSCs (self-employed workers with a limited company set up), it’s important to also consider the designation of employment status.
This was highlighted in a court case where a self-employed hairdresser who was working under what was described as an Independent Contract for Services, was in fact an employee and was therefore entitled to paid holidays, notice and redundancy pay.
Employment Judge Marion Batten, sitting in the Manchester Employment Tribunals, examined the case of a hairdresser working for Terence Paul (Manchester) Limited who was given a document to sign which described her as a “SEHS”, thought to be short for “self-employed hair stylist”. She was not offered any alternative contract or any choice over her employment status. In evidence, she said that she did not understand what this clause meant when she signed the contract.
The contract also included a number of provisions that aimed to demonstrate self-employed status, but in fact contradicted other key points. This included a clause that the hairdresser would receive 100% of the gross fees paid by customers, when in fact a 67% charge was applied for use of the salon's chair, washbasin, surrounding fittings, hot water, consumable stock and other services. Another clause specified how there were no fixed working hours but was contradicted by the fact that standard hours had to be worked, holidays had to be booked in advance and depended on the availability of other staff to cover.
The tribunal concluded that the salon exercised significant control over the hairdresser and her work, and that she was an employee. The tests of employee status were made out and it was found that the written contract did not reflect the reality of the working arrangements.
This landmark case is a hugely significant one for the personal care sector and many others, highlighting how many who believe they are operating as self-employed workers may in fact be employees, and should be entitled to things like holiday pay and sick pay.
Seek expert advice to help you make an informed decision
There are some complex considerations when it comes to employment status and speaking to a qualified accountant can help to map out all IR35 options and determine if other expertise is needed around things such as employment contracts.
A qualified accountant can also answer any questions you may have about working with other self-employed workers and the regulations you need to follow as a salon owner.