Independent contractor or employee? Avoiding the costly risks of misclassification

Independent contractor or employee? Avoiding the costly risks of misclassification

What is worker misclassification?

Misclassification of employees as independent contractors can open your business up to both financial and reputational risks. In this blog we’re going to break down exactly what is meant by the term ‘Worker misclassification’, what the potential risks are and the best ways to avoid them.

Worker misclassification is when a business records the status of a worker incorrectly. Most commonly, it is where an employee has been deemed as a self employed individual when in fact, they are actually an employee.

The responsibility of making the correct employment status decision and therefore the associated risks, varies depending on which country the contractor is working. With 43% of companies sharing that ongoing talent shortages is their biggest challenge, it’s inevitable that global recruitment will increase, as will the risks associated with engaging these workers. 

What’s the harm in getting it wrong?

We only need to look at the news headlines to see what the repercussions are for misclassifying your workforce. For example, a July 2022 review of Nike’s independent contractors in the US, UK, Netherlands and Belgium concluded that the company faces a “misclassification risk” of more than $530 million. More recently in 2023, Arise Virtual Solutions (AVS) were investigated for recruiting over 22,000 customer service representatives as contractors although they had no autonomy over their role. In 2024 as the case was settled, AVS were responsible for paying over $2 million in compensation to workers and almost $940,000 to the District of Columbia.

It’s not only the private sector that need to take the classification of workers seriously, as we saw when the 2022 NAO report found that public sector bodies in the UK were fined £263 million because they had not administered the IR35 off payroll working reforms correctly.

With all of this in mind, it’s important to remember that the risks are not only financial, but these cases and claims can cause damage to the reputation of your business. Along with the monetary fines, in the above example (AVS), the company were ordered to stop doing business in that district. The decision would have a huge impact to the operational efficiency and growth plans of the business. This could also negatively affect how the sale of your business goes when the time comes.

Worldwide trend

The global trend for contractors and their classification status is that governments are encouraging more workers towards traditional employment so they can benefit from full worker rights, and of course, pay the correct amount of income tax and social security. Companies are on board with this and seem to be taking a risk averse approach by adopting employed models.

You’re most likely familiar with the Off-Payroll Working Regulations the UK rolled out to both the public and private sector a few years ago which introduced a set of rules and criteria to crack down on misclassified workers. These regulations, also referred to as IR35, declared that the party in the contract chain paying the worker (the fee-payer) was ultimately responsible for the risks if they got the worker status decision wrong. If found that the decision made was incorrect, the liability, and therefore the risk, can also pass back up the supply chain to the hirer if other parties in the contract chain becomes bankrupt or otherwise unable to pay – this is known as third party debt transfer.

Although this has been in place now since 2017 in the public sector and 2020 in the private sector, there are a number of countries that have more developed rules in place such as The Netherlands for example. The Dutch law has identified 3 key components that determine if a worker is an employee or not. These are Authority, Personal Work and Wages. The rules are already in place, but the law is expected to be in place from 1^st of July 2025. Learn more about this from our recent webinar with Osborne Clarke here. 

How to protect yourself

The best way to protect your business from risks associated with the misclassification of workers is to understand the legal requirements for each country or jurisdiction your workforce is located. You’ll want to implement a robust process for checking and recording the status of your workers. For example, in the UK, to ensure compliance with IR35, companies can use the CEST tool. In the US that process varies depending on the state, but in most cases, companies must complete the Common law test which determines the employment relationship and therefore the worker classification.

If you have a large global contingent workforce, it can become an administrative burden to stay on top of the ever changing and growing requirements, which is why companies often outsource this responsibility to an expert. A specialist partner who has the knowledge, software and resource can provide employment solutions to help mitigate risks.

At Giant we do exactly that. Not only can we provide award winning employment to contractors in the UK, but contractors globally also get the same experience with our Employer of Record solutions. If you’re not sure where to start or whether you need to make changes to your existing process, we have a tried and tested audit that will give you an accurate view on where to focus your attention.

Join us for our upcoming webinar where we’re joined by tax experts Qdos to discuss IR35, HMRC activity and recent case examples.