How an individual is employed by an organisation to undertake work, for example, on an employed or self-employed basis, will be key in determining the legal rights and responsibilities between the parties. This includes important matters such as the way that person is paid, and any respective liabilities to deduct or account for Income Tax and National Insurance.
For employers, it can sometimes be easier to engage an independent contractor, especially for short-term assignments, rather than taking on the responsibility of a new recruit under a contract of employment. However, knowing the difference between a contract of service and a contract for service can be key to understanding your employer-obligations in an employment law and PAYE context, or as a client in an independent contractual context.
The following guide looks at hiring independent contractors, including how to determine the employment and tax status of someone hired to do work for your business, and the benefits of this type of employment status when compared with hiring employees.
Establishing contractor status
Under UK law, there are three main types of employment status: the employee, the worker and the self-employed. An independent contractor, as the name suggests, is someone who carries on a profession or business on their own account, and is hired by a client or customer to work for them on a self-employed basis under what’s known as a contract for service.
The independent contractor could be, for example, an IT consultant working on an IT project, or a freelance copywriter supporting a marketing campaign, although contractors can encompass different types of work across various industries. Typically, however, this is a person who will be taken on for the specialised knowledge and skills that they can provide, usually to work on a short-term assignment or specific project over a defined period of time.
There’s no single test for determining self-employed contractor status, although a person will be a contractor for both employment law and tax purposes if most of the following are true:
- they’re running a business for themselves
- the financial risk, and the success or failure of that business, lies with them
- they can decide what work they do, as well as when, where or how to do it
- they put in bids or provide quotes to clients or customers to get work
- they submit invoices to clients or customers for the work they’ve done
- they can hire someone else to do the work on their behalf
- they’re not under direct supervision when working
- they’re responsible for fixing any work in their own time at no extra cost
- a fixed price is agreed for their work, no matter how long the job takes to finish
- they’re paid per job, rather than receiving a regular salary
- they provide their own tools and equipment for the work
- they can undertake work for more than one client or customer at the same time.
In contrast, someone undertaking work for your business is probably classed as either an employee or worker if they’re required to personally undertake the work themselves, and a supervisor or manager is responsible for how, when and where that work is carried out.
What is the difference between contractors and employees?
There are three key factors that help to differentiate between contractors and employees:
Mutuality of obligation
Contractors are not required to accept or be offered work by a client or customer. In contrast, employees have an ongoing obligation to accept work offered, and the employer to provide and pay the employee for that work, typically at an agreed hourly rate, or on an annual salary paid either weekly or monthly;
Contractors will usually set their own schedule, having considerable freedom over the hours they work, as well as the way in which that work is carried out. In contrast, employees tend to be supervised, and subject to more control over when, where and how they perform their work. The employee may also be subject to restrictions around working for other people during and after their employment, whilst the contractor can work for several people at the same time and will not be bound by any restraint of trade clause;
Contractors can very often, at least in theory, hire someone else to undertake the work on their behalf, unless the contract makes specific provision otherwise. In contrast, employees must always undertake the work themselves, and will not be permitted to send a substitute or subcontract their work to someone else.
Employment status can therefore be defined by how dependent a person is on your business for work, how much control you have over them and the work that they do, and whether they’re expected to carry out the work themselves or can send someone else in their place.
What is the difference between contractors, employees and workers?
Broadly speaking, there are two factors that differentiate contractors from workers: control and substitution. The key difference between an employee and worker is mutuality of obligation, where an employee is required to work a minimum number of hours and be paid for that work. A worker, on the other hand, is not necessarily offered regular or guaranteed hours, and has little obligation to make themselves available for work, but should do the work that they’ve agreed to. Whilst employee status can cover part-time workers, or even those working irregular, term-time or more casual hours, an individual is more likely to be a worker where mutuality of obligation is absent, such as those on zero-hours contracts.
Modern working relationships can be difficult to classify, where new ways of working have emerged over recent years, especially under the gig economy, including the likes of Uber drivers and Deliveroo cyclists, which no longer neatly fit within current employment status definitions. You may also find that working relationships can evolve over time.
When you initially bring someone new into your business, defining their employment status should be relatively straightforward. The distinction between a permanent member of staff, whether this be on a full or part-time basis, and a contractor coming in on a more temporary basis, is usually quite clear cut. However, these distinctions can often become blurred as contractual relationships evolve, for example, where the freelance copywriter has begun working 9-5 on your marketing team and getting paid monthly. In these circumstances, the original contractor agreement may no longer be fit for purpose, placing you in breach of your employment obligations to someone who now, at the very least, has worker status.
Regardless of what’s in writing, it’s the actual working arrangement that determines an individual’s employment status in the eyes of the law, where someone may start out as a contractor but a change in circumstances results in a change of status. This could include where control shifts to the client around working hours and how that work should be carried out, and an expectation arises that the contractor must carry out that work themselves and not provide a substitute. If so, the relationship may have evolved into one akin to employment, where the contractor will gain entitlement to a number of worker’s rights which the employer must fulfil. If you add into the mix mutuality of obligation, where the client is expected to provide work and the contractor to accept it, these rights will be even greater.
How does contractor status affect the parties rights and responsibilities?
A person’s employment status is important as it affects their legal rights, what they’re entitled to and what can be expected of them.
Employees are afforded the most protection because they have the weakest bargaining position. All employees are workers, but an employee has extra employment rights that don’t apply to workers, such as the right to a minimum notice period, not to be unfairly dismissed and the right to a statutory redundancy payment. However, workers still have some level of legal protection, including the right to minimum pay, as well as statutory holiday and sick pay.
However, in stark contrast, the genuinely self-employed, including independent contractors, have none of these protections. This is because contractors are their own boss and are therefore responsible for themselves, from providing their own financial cover in case of illness or injury, to declaring and paying their own Income Tax and National insurance.
In a contractor-client scenario, the contractor will not be paid through PAYE, and the legal rights and responsibilities between the parties will be primarily determined by the terms and conditions of their contract for service. As a client, you will still have certain other legal responsibilities toward contractors, including the statutory duty to ensure the health and safety of these individuals when undertaking work for you or visiting your premises. However, you will not be bound by the various statutory and contractual duties that an employer owes to an employee or worker, as set out in the employment contract or implied as a matter of law.
How does contractor status affect tax and National Insurance liabilities?
A genuine contractor should not be paid via PAYE, but instead must declare and pay any tax and National Insurance through self-assessment. However, certain businesses engaging the services of a contractor via an intermediary company to avoid pay-rolling these individuals, may be classed as a ‘deemed employer’ under HMRC’s IR35 rules. It’s therefore important to bear in mind that a person’s employment status for tax and National Insurance purposes is not necessarily the same as their status for employment rights purposes.
The IR35 reforms, that came into force on 6 April 2021, mean that where an individual falls within the scope of the rules, for example, by providing a personal service to a medium or large-sized organisation, the deemed employer will be required to deduct tax and National Insurance through PAYE in the same way as for any other employed worker. Further, the organisation responsible for engaging the contractor will also be liable for determining that person’s IR35 employment status for tax purposes and whether the IR35 rules apply.
What are the benefits of hiring contractors?
There are various benefits to hiring a contractor, rather than taking on a new employee under a contract of employment, especially for short-term assignments or projects, including:
Contractors can bring knowledge and skills to your organisation that you may not necessarily need to access on a day-to-day basis, but require temporarily. In this way, you can get the job done in the most efficient and cost-effective way, without the long-term investment of a permanent member of staff. As the contractor comes armed with a ready-made skillset, they can also meet urgent work demands if you need help fast, without on-the-job training or anything other than a basic induction to the business.
Fewer obligations as an employer
Beyond the terms and conditions of any contractual agreement, you won’t be obliged to continue supplying work and paying contractors if your demand in workload reduces or if their personal circumstances change. For example, if a contractor wants to take maternity, paternity or parental leave, there will be no need to keep the role open for them or to make any statutory payments. You’ll also not be liable to pay any statutory annual leave or statutory sick pay for a contractor.
Fewer administrative responsibilities
You won’t have to put a contractor on your payroll or pay any National Insurance contributions for them, as the genuinely self-employed will be responsible for accounting for any tax and National Insurance payments themselves. Equally, as the contractor has no entitlement to holiday or sick pay, or any other statutory leave entitlement, there will be no administrative burden that comes with this.
These are just a few of the benefits of hiring contractors when compared with taking on a permanent member of staff, where many modern businesses, especially those moving through a period of growth or transformation, will have a mix of employees and contractors making up their workforce. However, in these scenarios, it’s vital that you regularly review your contractual relationships to ensure that contractors have not evolved into workers with time.
DavidsonMorris’ employment lawyers can help with all aspects of recruitment and employment contracts, terms and conditions. We have particular knowledge of complex issues relating to employment status and the legal issues relating to hiring independent contractors. For help and advice, speak to our experts.
Employing contractors FAQs
What laws protect independent contractors?
In a contractor-client relationship, the legal rights and responsibilities between the parties will be primarily determined by the terms and conditions of their contract for service.
Do contractors have any rights?
A contractor’s rights will stem from the client contract, including the right to be paid a fee for the work to be undertaken. This is in contrast to employees, where certain statutory rights can be implied into the employment contract.
What is the new law for independent contractors?
On 6 April 2021 new IR35 rules came into effect, meaning that where an independent contractor is engaged through an intermediary company, but their working arrangement is effectively one of employment, they will need to be pay-rolled.
Can a contractor be held liable?
As a contractor works on a self-employed basis they’ll usually be responsible for any negligence on their part, although where the working arrangement is akin to employment, the client or employer may be held vicariously liable.
Last updated: 27 October 2021