Employee is a person who works under a contract of service whereas self-employed is a person who works under a contract for services (Melville, A. 2011 p.84). As a self-employed person, they enjoy a wider range of tax benefits and deductible expenses when compared to employees. Self-employed are allowed to pay tax by installment and pay tax much later than employees, who normally pay income tax under PAYE system.
The main criteria to distinguish two types of contracts of services or for services will be as follows:
1. Control. Self-employed people have control over their work than employee who is unable to choose whether or not to do certain work.
2. Remuneration and financial risk. The Employees will still continue to receive monthly salary or wages regardless if their employer is making profit or loss in the business, and the employees do not risk their own capital in the business. In contrast, self-employed people are being paid a separate fee for each of the jobs being carried out. They may make profit or loss or even lose their capital if they fail in their business.
3. Equipment. Self-employed do provide their own equipment but employees do not.
4. Work performance and correction. The client does not need to pay extra in order get the job satisfactory by self-employed. Whereas the employees get paid for the original work and the corrections towards the mistake done.
5. Holidays and sickness. Self-employed people do not get paid when on holiday or ill, they only get paid by their clients for the work that they do. However, the employees are probably to receive holiday and sick pay from their employers.
6. Exclusivity. An employee is employed by just one employer and is an essential part of the employer’s business. Self-employed people mostly have many clients and are not essential part to any of their clients’ businesses.
Employment Income
Employment income refers to an income a person receives as the holder of an office or employment. (Melville, A. 2011 p.84)
Generally, it means the earning that the employees received in connection of an employment. Such as salaries, wages, bonuses, fees, payment on termination of employment, expense allowance, pension arising from an employment, commissions and benefits in kind.
An employee is not necessary receiving income directly from employer; it could be received from someone else for the result of employment. It is still consider as taxable income no matter who the employee received from. Example, waiter’s tips are taxable although it was not paid by employer.
The statute ITEPA 2003 Section 336 says that in order to qualify for allowable expense under employment the expenses incurred must be wholly, exclusively and necessary in the performance of duties of the employment.
Wholly and Exclusively:
Expenses that incurred are because of the activity and for the nature of the work. Example: Someone who works in the clean room have to buy safety wear. If the expenses are double edge it cannot be claimed. Example: Office uniform can be claimed but the normal work wear other than uniform cannot be claimed.
Deduction is allowable if the cost can be apportioned between a part that is incurred wholly and exclusively in the performance of the duties of the employment and a part that is not, an apportioned part can be allowable.
Necessarily:
An expense is said to be necessarily incurred when it is necessary for the performance of the duties of the employment and not because of the requirement of the employer or employee. The expenses can only be allowed if each and every holder of an employment were to incur the same expenditure.
Trading Income
The term “trading income” comprises of both income from a trade and income from income from a profession or vacation.
The “Badges of trade” has been used to indentify between trading and non trading activities. The badges of trade consist of subject matter of the transaction, length of the period of ownership, frequency of transaction, supplementary work required, reason for sale and motive (Lee, N. p.263).
ITTOIA 2005 Section 34 stated that for self-employed, expenditure can only be deducted against trading income when the expenses incurred wholly and exclusively for the purpose of trade.
There are two tests that determine whether a particular expense is allowable for tax deduction:
1. The “remoteness test” is use to determine if there is any connection with the trade, expenses that has no connection is disallowable. In Strong & Co of Romsey Ltd v Woodifield (1906), a brewery compensate a hotel guest that was injured by a falling chimney, the expenses was disallowed by court because expenses were incurred by the brewery as a property owner and not as a trader. Therefore, the test has failed.

2. The “duality test” is use to test if the expenditure serves both business and private purpose. If the expenditure can be apportioned between private and business then the business element can be deducted. In Mallalieu v Drummond (1983), the cost of black clothing worn in court by a lady barrister was wholly disallowed, since it was not possible to apportion the parts which satisfy professional standard and the same time provide warmth and decency.
Below are the deductable expenses compared between self-employed and employee:
Entertainment
Employee:
Entertainment expenses are disallowable to claim and an employee who is required to pay such expenses personally cannot claim any deduction. However, if an employee get reimburse from the employer or received a specific amount from employer for the entertainment expenses spent. Then the employee may use the amount received to set off against entertainment incurred. This rule is subject to the overriding rule when the entertaining expenses must be incurred wholly, exclusively and necessarily in the performance of the duties of the employment. (ITEPA 2003 Section 356)
Self-employed:
ITTOIA 2005 Section 45 says that entertaining expenses in connection with the trade (i.e customer) is not allowable under self-employed. Staff entertaining costs are allowable, such as a company annual dinner, is an allowable expense for the company and it will not be classified under benefit in kind for employee provided that the cost per head is less than £150 per annum and the event is open to all staff whereby “each and every person” rule applied here. Travel between home and work
Employee:
Generally, an employee is allowed to claim full tax deduction on the business journey that he travelled. The definition of “business journeys” is travelling from one workplace to another or from home to temporary workplace or vice versa.
The Statute ITEPA 2003 Section 339 stated that a workplace is a place at which employee’s attendance is necessary in the performance of duties of the employee. Whereas permanent workplace refers to the employee who regularly attends in the performance of duties and it is not temporary workplace. Temporary workplace is a place where employee attends in the performance of duties of employment in limited duration or for some other temporary purpose.
However, journeys between employee’s home and permanent workplace are disallowed because it is not business journeys and it is referred as ordinary commuting and it has to be borne by the employee. The same treatment even when the employee has to attend a permanent workplace after working hours. In some cases, the journey between a temporary workplace and home may not be qualified for tax deduction if the trip is substantially similar to ordinary commuting where it uses the same roads or transports for most of the journey.
Self-Employed:
If Self-employed work from home and the home referred as “base of operations” where the tools and equipment of the trade were kept, business records were kept and written up at home. Therefore, the cost of commuting between home and where the work is carried out should be deductable. However, if the base of operations is other than home, then the cost of commuting between home and base of operations are disallowed because it is referred as ordinary commuting and all private travelling are disallowed.
Training Expenses
Employee:
The statute ITEPA 2003 Section 250 stated that employees entitled to tax exemption for work related training paid by employer. Tax relief will not be given automatically to those employees who pay for their own training, regardless the purpose of the training even if the training will help in their duties. It will only be given when the training satisfy the “wholly, exclusively and necessarily” rule. If the employees need training necessarily for the performance of their duties then the tax relief will be granted.
An employee is sent for training in order to enable him or she to perform out a new job will not qualify for tax relief.
Self-Employed:
The event of tax relief for training paid for by self-employed is different. Any training that can equip their employees to be able to do their jobs better and this may includes training that may not see an immediate impact on their ability to perform the duties will be allowable.
Training expenses has to be incurred “wholly and exclusively” for the purpose of trade in order to qualify for deductible expenses. It seems more liberal definition than what applies to employee. However, a further study is needed identify if the training expense is an expense or an investment. For example if the training is to gear up the employee with the new products development then the cost of training is a capital nature and the tax relief should be claimed by capital allowance.
Work From/at Home
Employee:
If working from home is the requirement of the employment for the performance of the duties and there is an objective reason for doing so. Then a range of allowances are available and should be outlined in the employer’s home working policies and procedures. Regardless of the method of payment, all non-cash benefits and expenses provided to employees in the course of their employment are normally taxed under PAYE.
For ‘home-based’ employee, such as if the home address appears on the business cards, then the way that work-related travel expenses are treated for taxation purposes is different to being based in the employee’s premises.
Self-Employed:
For self-employed, a range of possible claims may be allowable against tax covering a percentage of the running costs of the home. Self-employed is allow to claim for a percentage of heating, lighting, telephone, depreciation of fixtures and fittings, installation of extra power supply, cleaning costs, business insurance, office equipment and refurbishment, postage, stationery, work-related publications, and membership of professional bodies related to the work.

List of references:

Great Britain. Income Tax (Earnings and Pensions) Act 2003: Employment Income: Deductions Allowed From Earnings, Available at: http://www.legislation.gov.uk/ukpga/2003/1/part/5 (Accessed: 1 December 2011).

Great Britain. Income Tax (Trading and Other Income) Act 2005: Trading Income, Available at: http://www.legislation.gov.uk/ukpga/2005/5/part/2 (Accessed: 1 December 2011).

HM Revenue and Customs, Tax relief for specialist tools or clothing, Available at: http://www.hmrc.gov.uk/incometax/relief-tools.htm (Accessed: 30 November 2011).

Lee, N. (2009) Revenue Law: Principles and Practice, 27th ed. Tottel Publishing

Melville, A. (2011) Taxation Finance Act 2011, 17th ed. England: Pearson Education Limited