Law firm consultants: Employment status indicators and tax impacts

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Determining whether a worker is employed or self-employed for tax purposes has long been a complex issue. This challenge has intensified in recent years due to tax regulations such as IR35 and Corporate Criminal Offence, as well as conflicting decisions from the Tax Tribunal and a shift in workforce dynamics, particularly with the increasing use of contingent workers.

The legal sector, which frequently engages non-employed consultants, faces specific tax challenges and risks. These issues are particularly problematic when it comes to HMRC audits or on corporate transaction due diligence. For law firms, two key risk areas are ex-partners and client-facing consultants.

Ex-partners

In many traditional law firm partnership agreements, partners are required to retire at a set age—commonly 60 or 65.

However, the problem arises when partners are not ready to stop working at what is now considered a relatively young age to retire. Many feel they still have valuable contributions to make, and the firm, similarly, may be reluctant to lose long-standing partners, as their experience and client relationships are hard to replace.

As a result, former partners may be re-engaged as a self-employed consultant after retirement, often working reduced hours – an arrangement that is convenient for both parties (as it’s thought to be easier than changing the long-standing partnership agreement) but one that can complicate the tax classification.

For a worker to be considered self-employed in tax law, they must meet two fundamental criteria: independence from the business in which they are working, and be operating in business on their own account. These conditions are often difficult to demonstrate in the case of ex-partners, especially when they are still working within the same firm.

The key issues that create complications include:

  • The ex-partner working exclusively for the law firm and a lack of multiple clients undermines the self-employment status.
  • The ex-partner continuing to hold a prominent position in the firm i.e. making internal decisions and being listed on the firm’s website.
  • The ex-partner continues to carry out the same duties as they did before retiring as a partner, such as attending leadership meetings, managing teams and client relationships and signing off reports.  

In these situations, the law firm must prove the ex-partner’s consulting role is substantially different from when they were a legal partner. Furthermore, the firm must demonstrate the ex-partner is acting as an independent consultant when working for the business and that the terms under they are working are consistent with genuine self-employment.

Failure to adequately substantiate these distinctions could lead to HMRC challenging the ex-partner’s employment status for tax and National Insurance Contribution (NIC) purposes. Depending the specific areas of tax legislation that apply and on the contractual arrangements, this could result in the law firm being liable for PAYE, employer NIC, employee NIC (where due), interest and penalties. These liabilities can date back as far as six years, potentially resulting in a significant settlement to HMRC.

Client-facing consultants

Another significant risk areas for law firms arises when consultants are hired in client-facing roles.

Whether the consultant is temporarily replacing someone on long-term leave or absence, increasing capacity during a busy period, or due to budget constraints, this arrangement could expose the firm to HMRC scrutiny and additional liabilities, and penalties if the consultant is paid off-payroll.

Given the complexity of employment tax law, each case must be considered individually.  It can, however, be difficult to defend and evidence why such arrangements indicate self-employment, especially when applying the key ‘Employment Status Indicators’ used by HMRC and the Tax Tribunal as the scenarios below highlight.

  • Mutuality of obligation: If the consultant is expected to service clients, and the firm provides work by granting access to its client base, this can create a strong mutuality of obligation, which is a pointer towards employment.
  • Personal service: Law firms often hire consultants based on their experience and qualifications, possibly through a formal recruitment process. The requirement for the consultant to deliver personal service is a key indicator of employment.
  • Adherence to firm policies: Consultants are often expected to carry out client work in accordance with the firm’s internal policies and procedures, such as client onboarding, time recording, quality control and billing practices. There may also be restrictions on the consultant’s ability to work with other law firms during or after their engagement. The level of control over these aspects is a common feature of employment relationships.
  • Insurance and risk absorption: It is typical for consultants to be covered by the law firm’s Professional Indemnity Insurance and other relevant business insurances, along with regulatory registrations when servicing clients. Additionally, the firm often absorbs any write-off of costs or non-payment of fees by clients. The lack of financial risk for the consultant in these areas is also inconsistent with self-employment status.
  • Integration in the firm: If a consultant works in a manner similar to employed staff - using the same systems with the same access, representing the firm when interacting with clients, working as part of a team and being integral to the day-to-day operations – this suggests they are part of the firm, and this integration is a crucial factor in determining employment status for tax purposes.

Correct classification will avoid financial and reputational damage

In both of these scenarios, law firms must be cautious and ensure they can defend the self-employment status of their consultants.

Unless ex-partners or client-facing consultants are treated as employees and subject to payroll deductions, it is impossible to completely rule out the possibility of an HMRC challenge to their tax treatment, or for this to become a red flag during due diligence, where payments are made off-payroll.

However, not all such arrangements will necessarily be deemed employment for tax purposes. If the substance of the arrangement reflects a genuine, independent, consultancy relationship, it may be possible to defend the self-employment status. This would require solid evidence of the working relationship and alignment with the key ‘Employment Status Indicators’ and case law precedent.

That said, in our experience most ex-partner and client-facing consultants engagements within the sector lack many of the characteristics needed to classify them as self-employed under tax rules. This leaves law firms potentially exposed to significant financial and reputational risks if the consultants are paid off-payroll on a gross basis.  


If you would like advice about the tax treatment of consultants working for your law firm, please get in touch.

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