Many small businesses consider using self-employed contractors (freelancers) rather than hiring traditional employees, to maintain flexibility or reduce obligations. It’s possible to do this, but it’s crucial to understand the differences in status and to use the appropriate contract for each. Misclassifying an employee as a contractor can lead to legal and tax troubles. Here’s the rundown:
- Employment vs. Contracting – Legal Status: An employee works under a contract of employment (also called a “contract of service”). They are part of your business, under your control, and entitled to a range of statutory rights (like sick pay, holiday pay, pension, protection from unfair dismissal after 2 years, maternity/paternity leave, etc.). You as the employer must also pay employer National Insurance contributions, operate PAYE tax withholding, and follow employment laws (minimum wage, working time limits, etc.). A contractor or self-employed individualworks under a contract for services. They are essentially an independent business you are engaging. Contractors aren’t entitled to most of the rights mentioned above – they invoice you for their work, handle their own tax, and generally have more control over how and when they work. UK law may classify someone as a “worker” (an intermediate status with some rights like minimum wage and holiday) even if not a full employee, depending on the relationship. So simply labeling someone a contractor isn’t conclusive – how the relationship operates in practice matters.
- Contract Differences: If you engage a genuine independent contractor, you should use a Service Agreement or Consultancy Agreement rather than an employment contract. Key differences in that contract compared to an employment contract include:
- No job title or ongoing position: Instead, the agreement will describe the services or project deliverables the contractor will provide. It may be time-bound or project-bound (e.g., “to develop a website according to specification X by date Y”). It usually won’t use the language of “duties as assigned” as an employment contract might, but rather specific outcomes or a scope of work.
- Independence and Control: The contractor agreement typically states that the contractor has control over how the work is done. For example, while you might set goals or milestones, the contractor can determine their own schedule or methods (within reason). The agreement often clarifies that they can provide services to others too (non-exclusivity) and might even include a clause allowing substitution – i.e., the contractor could send a substitute to do the work if approved. (In reality, many freelancers do the work themselves, but the theoretical right to substitute is a factor tribunals consider in assessing status; employees generally cannot send someone else to do their job, contractors can).
- Payment and Tax: A contractor is usually paid against invoices for work done, often after completing milestones or on a schedule (weekly, monthly) for time worked or deliverables. There’s no PAYE – the contract will say the contractor is responsible for their own Income Tax and National Insurance, and is not entitled to holiday or sick pay. The contractor may charge VAT if they’re VAT-registered. The contract may include late payment interest according to standard commercial terms (there’s even a Late Payment of Commercial Debts Act that can apply).
- No employment benefits: The contractor agreement will explicitly state that statutory employment benefits do not apply – so no holiday, no pension from you, no parental leave or anything (beyond any minimum rights a self-employed person might have in a B2B contract, like they’re protected against discrimination if they’re actually a “worker”). This should be clearly laid out to manage expectations. Contractors charge a rate that presumably factors in the fact that they cover their own benefits and downtime.
- Termination: Unlike employment where you have notice periods and potentially unfair dismissal rules after 2 years, a contractor agreement can have more straightforward termination clauses. Often either party can terminate with a shorter notice (or in some cases immediately, subject to payment for work done up to then). There’s no concept of redundancy pay or unfair dismissal – as a commercial contract, if it’s ended according to the contract terms, that’s it.
- Intellectual Property and Confidentiality: Much like with employees, you need to address IP – but note, with an employee, any IP created in the course of employment automatically belongs to the employer by law. With a contractor, the contractor typically owns any IP in their work product by default (unless agreed otherwise). So, include a clause assigning intellectual property rights in the delivered work to your company upon completion and payment. Confidentiality clauses are also essential, as contractors will learn about your business and you want to ensure they treat information sensitively just like an employee would (and still do so after their contract ends).
- Liability and Insurance: Employment contracts rarely, if ever, make an employee liable for damages (beyond possibly saying serious negligence could result in dismissal). In a contractor contract, it’s common to include that the contractor is responsible for their own insurance and may be liable if they mess up and cause loss. For example, you might require the contractor to hold professional indemnity insurance or public liability insurance. The contract may have indemnities or liability caps either way. Essentially it’s more of a business-to-business contract.
- Integration and Facilities: The contractor agreement might clarify that the person is not integrated into the company’s workforce. For example, it could state they will generally work off-site (if applicable) and are not entitled to an office or resources except as necessary. If you do provide certain equipment or access, outline that. Also specify that they are not to hold themselves out as an employee or agent of the company except as needed to perform the services.
- IR35 / Off-Payroll Rules: If you hire a contractor who works through their own limited company, be aware of IR35 rules (off-payroll working). Essentially, if the contractor is effectively working as an employee in all but name, the tax law might require you to treat them like an employee for tax purposes. As of recent changes, medium/large companies are responsible for determining IR35 status of contractors. Small companies are exempt from having to do the IR35 assessment (the contractor’s company then is responsible), but it’s still wise to ensure the contract and working practices reflect genuine self-employment. Factors include having that control, possibility of substitution, no guaranteed minimum hours, etc. A well-drafted contractor contract from a service like British Contracts will include clauses aimed at demonstrating an independent contractor relationship.
So, can you hire someone as a contractor? Yes, if the nature of the work and the relationship truly support that status. Examples of genuine contractors include a web designer you hire for a one-off project, an accountant who comes in twice a week and also serves other clients, and a consultant with special expertise engaged for a short-term analysis. They will likely use their own tools, have a high degree of control, and bear some financial risk (e.g., if they take longer, they eat into their own time/cost).
On the other hand, if you have someone working 9–5 under your direction, doing core work of your business alongside employees, for months on end, they may well be an “employee” in the eyes of the law regardless of calling them a contractor. It’s the reality that counts. Misclassification can lead to claims for backdated holiday pay, or HMRC can demand back taxes. A cautionary tale: many companies tried to label workers as self-employed to avoid benefits/taxes, but over time the courts have frequently reclassified them (as happened with some delivery drivers, couriers, etc., who were deemed “workers”).
To avoid trouble: use a strong contract for services agreement for any contractor, outlining the independent nature. And ensure in practice you respect that independence (for example, don’t micro-manage their daily routine as you would an employee). If you’re unsure, consult British Contracts. Some businesses bring people in as contractors during a trial period and then move them to employment. If you do, be aware that if they’re essentially acting like an employee during that time, they might accrue rights. It’s cleaner either to use a short fixed-term employment contract for trials or be very clear it’s a freelance gig that may lead to an offer.
In summary, choosing between a contractor and an employee depends on the work structure. Contractors come with fewer obligations for you (no holiday/sick pay, etc.) and can be cost-effective for short-term or specialised needs. Employees offer stability, and you can build them into your team long-term; however, you also take on more responsibilities. Make the decision consciously and document it with the correct type of contract. British Contracts can provide both bespoke employment contracts and bespoke contractor agreements under our highly competitve Gold and Platinum packages, helping you set up whichever relationship suits your situation with proper legal wording. Just don’t try to have it both ways (calling someone a contractor but treating them like staff) – that path can lead to expensive legal disputes.