Expanding your business is an exciting step for any entrepreneur. But there’s a lot to think about, and how you choose to expand your team will have a huge impact on your business. 

You know you need more people, but what is right for your business? Do you need an employee or contractor?

It’s important that you get it right, as there will be different employer and tax obligations for both.

Here’s a guide to help you understand the difference between employees and contractors.

What is an employee?

This may seem obvious, but there is more than simply working for a company that defines someone as being employed.

An employee will have an employment contract and have extensive employment rights.

An employee is someone who:

  • Is obliged to carry out work as part of their role (and their employer is obliged to provide work)
  • Is subject to more control over how they perform their work, such as when and where 
  • May be subject to restrictions around working for other people during and after their employment
  • Is not able to provide a substitute to carry out their work 
  • Will likely be paid an annual salary or hourly rate, agreed at the start of the employment

Employees are often more embedded in the business, which can provide consistency for your customers. They are more likely to be loyal to the business and help drive collaboration and teamwork.

Employees are also more dependable in terms of availability, as you’ll always have them as a resource during set working hours to ensure that you can meet core operational demands.

If the work someone is doing is an integral part of the day-to-day running of the business, it’s likely they are more suited to being an employee instead of a contractor.

What is a contractor?

A contractor is someone who is self-employed and carries out work for you. They will typically be under contract for a defined period of time or specific project, and provide specialised knowledge and skills. 

Depending on the type of services they provide, they may also be referred to as freelancer or consultant.

A contractor is someone who:

  • Is paid for a specific job/project, or for an agreed period of time, as opposed to receiving an annual salary from you
  • Is invoiced for the work they do
  • Is responsible for their own tax and National Insurance
  • Has their own professional insurance
  • Works for other companies
  • Determines where, when and how they work
  • Provides and uses their own equipment

Contractors are great for working on specific projects, but whose skills are not required for the day-to-day running of your business. 

They can help to your business if you have urgent or temporary work demands, as they will not require a formal induction or undertake training. They can get started quickly and easily on the work they need to do. 

What are the differences between employees and contractors?

There are three key factors that should help you spot the difference between employees and contractors under current UK law:

  1. Mutuality of obligation: 
    • Contractors are not required to accept or to be offered work.
    • An employer is obliged to provide work to an employee and they are obliged to carry out the work, under the terms of their employment contract.
  2. Control: 
    • Contractors have the freedom to set their own working schedule, as long as the work is complete within agreed timeframes, how and when they choose to conduct the work is up to them.
    • Whilst some companies may offer flexible hours in terms of start and finish times, an employee would normally be expected to work a set number of hours which do not vary each week/month. 
  3. Substitution: 
    • In most cases, a contractor is able to hire someone to conduct the work on their behalf.
    • An employee is obliged to carry out the work themselves, rather than sending a substitute. 

Understanding the legal and tax definitions of employment status

In terms of tax, there are only two types of status – employed and self-employed. The rate of tax that someone pays and how they pay it is determined by their status.

An employer is responsible for deducting tax and national insurance at source (PAYE) from the salary paid to employees. This is taken care of during the payroll process. Self-employed individuals are responsible for paying their own tax and national insurance under self-assessment.

In terms of employment law, there are three types of status:

  1. Employed
  2. Self-employed 
  3. ‘Worker’

A ‘worker’ is the point between employed and self-employed. 

On the surface someone may seem like they are self-employed due to some of their behaviours, such as using their own tools and equipment and setting their own work schedule. However, if they depend on the other party for their income (or large part of it), they edge more into the ‘worker’ category. 

As well as being somewhere in between employed and self-employed in terms of behaviour, this also extends to employment rights. ‘Workers’ will have some core employment rights, but fewer than employees. 

A contractor can fall into either of the self-employed or worker categories, so it’s important that you understand the difference so you know your obligations.

IR35 and off-payroll workers

IR35 is tax legislation that affects contractors and employers who engage them. 

Since April 2021, IR35 has meant that businesses must determine whether contractors they work with should be taxed in the same way as employees. Previously, this was determined by the contractors themselves.

However, in a shock announcement during the mini-Budget on 23 September 2023, Chancellor Kwasi Kwarteng announced that the government is seeking to roll back these changes in order to reduce the administration burden on businesses that engage contractors, making it easier for them to be more productive and grow. 

Whilst the changes are not set in stone, the repeal of IR35 is currently expected from April 2023. 

Ultimately your business need will determine whether you need to hire an employee or contractor, but it’s important you know the difference so you understand your obligations.

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Posted by Clear Books