At one time or another, you may find yourself working with or becoming a contractor. But what is a contractor, and how are they different from other forms of employment?

Types of employment

There are three different ways you can be employed in a job in the UK:

• As an employee of a company (with a permanent or fixed-term contract), where you receive a salary and benefits and your employer deducts PAYE Tax and National Insurance Contributions from your pay. You’re supervised and obliged to do the work that you’re contracted to do. Employees have employment rights
• As a worker, where you work on a temporary basis, usually as an Agency Temp or a Casual Worker (short-term contracts or on a zero hours contract), but you also have PAYE Tax and NI contributions deducted from your pay by the employer. Workers have some employment rights
• As a self-employed person – you can be called a freelancer, sole trader, contractor, limited company. The self-employed have very few employment rights at present.

{{tax-guide}}

What is a contractor?

A contractor provides services to a specific client under specific terms. A contractor, however, can either be classed as:

• A worker or an employee (if they work for a client through an Umbrella Company or Agency – then the Umbrella Company/Agency is their Employer; not the Client) or as
• Self-employed (if they're a sole trader or have a limited company of their own)

A contractor is different to a temp (even though they may both work for an end client through an Agency) because:

• A temp will be paid by the Agency. The work they do is under the Client’s control like any permanent employee (you’re supervised and told what times to start and finish work, and what to do). Temps are eligible for holiday and sick pay. From October 2011 they’ll be, in most circumstances, eligible for ‘equal treatment’ under the new Agency Worker Regulations. Temping is often done in the short-term and/or for a transitional period while they look for another permanent job
• A contractor, however, is responsible for their own ‘business’ dealings and should have control of how and when they do their work. They would either be employed through an Umbrella Company who pays them (and pays their taxes) or have their own limited company, or they are a sole trader and pay their own taxes. They may or may not work through an Agency. They can have a series of assignments from several clients at the same time. They may hire a ‘substitute’ to do the work for them. Contractors are generally higher-paid ‘professionals’ who are contracting in the long-term. See our latest article about 'false' self-employment which has been covered in the April 2014 Finance Bill.

When a contractor works for a client, in comparison to an employee working at the same company, contractors will generally:

• Have significantly more freedom regarding the work that they do or don’t take on – they’re not obliged to accept a contract. This is called ‘Mutuality of Obligation’. In an employment contract (a ‘contract of service’), the employer is obliged to provide work and the employee is obliged to do that work. A Contractor has a ‘contract for services’ in which there’s no such obligation – the contractor agrees to provide services to the client in accordance with an agreed schedule. The contractor assumes liability for any errors or omissions. Once the project outlined in the contract has been completed, the client does not have to offer the contractor any more work. If the client does choose to offer more work, the contractor doesn’t have to accept it

• Have freedom and control over when and where they do the work, however, the nature of the job usually involves working on a client’s site at some point. Although the client will probably have a clear idea of the ‘deliverables’ that they require, a contractor's working patterns can’t be defined by the client

• While employees are paid for the hours they work (generally paid weekly or monthly), contractors may be paid on completion of specific ‘milestones’, which should be defined in the contract, or invoice their clients for the services they provide on a regular basis (often monthly)

• Have some tax advantages, but there are disadvantages – mainly the lack of employment rights and benefits. While employees of the client are generally entitled to redundancy pay, holiday and paid sick days etc, contractors aren’t.

• Have no redress if the client terminates or chooses not to renew the contract. The contract between the two parties should clearly set out the way in which termination will be handled, if either side can give notice to terminate and that either party can terminate the agreement immediately if a breach of contract has occurred from either side

• Contractors also have rights under The Conduct of Employment Agencies and Employment Business Regulations 2003 - see our new guide here.

Legal structures for contractors

Deciding on a suitable legal structure for working as a self-employed person should be one of your first tasks when starting out as a contractor.

Up until the 1980’s the most common way of operating as a contractor was as a sole trader.

However, in the late 1980’s HMRC bought in a rule that made Recruitment Agencies liable for unpaid tax if they engaged self-employed workers and paid them gross. This stopped Recruitment Agencies using sole traders, so contractors were forced to set themselves up as their own limited company (as the Agency does not have liability for unpaid taxes when dealing with a limited company).

Following the introduction of IR35 in 2000, there are now a range of company structures that can be used. The decision on which structure to use will depend on varying factors, including whether or not your contracts are likely to fall within the IR35 rules. It’s therefore vital that you understand what IR35 means – a good place to start is our comprehensive IR35 hub, which includes all of our articles, our jargon-free business guide, and our IR35 service. Alternatively, if you'd simply like to get started, find out more about how to become a contractor and begin your self-employed journey today.

If you are an Employer and need ongoing professional help with any staff/freelance issues then talk to Lesley at The HR Kiosk - a Human Resources Consultancy for small businesses – our fees are low to reflect the pressures on small businesses and you can hire us for as much time as you need.

Please note that the advice given on this website and by our Advisors is guidance only and cannot be taken as an authoritative or current interpretation of the law. It can also not be seen as specific advice for individual cases. Please also note that there are differences in legislation in Northern Ireland.