Contractors, according to the HMRC, are a type of self-employed worker, much like freelancers. There are tons of benefits to engaging with independent contractors, the least of which is the increased flexibility and decreased overhead costs when seeking out highly specialised skills for specific projects.
While working with contractors certainly has its benefits, you should take the time to weigh up your options and be aware of the potential risks when it comes to employing contractors in the UK. In order to avoid any legal implications, ensure that you take the time to learn about the differences between contractors and employees, as well as the legal risks faced when engaging with contractors.
Difference Between Contractor and Employee
The meaning between a contractor vs an employee in the UK is quite clear cut. However, the line that distinguishes the two types of workers is relatively fine, and, as such, it is a line that is rather easy to cross. Let’s go over the biggest differences between who would be considered an employee and those who would be considered a contractor.
1. Payment and Taxes
income tax and National Insurance, which would usually be withheld from the employee’s salary.
Employees are also legally required to be provided benefits, such as health insurance, paid leave and pension
plans. These come at the expense of the employer and are automatically enjoyed by an employee who decides to work for a company.
On the other hand, contractors are not on the company’s payroll and tend not to be paid a salary. Instead, they are paid an agreed amount based on a pre-determined hourly or daily rate or on a per-item basis. Independent contractors are solely responsible for paying their own taxes and, thus, their client doesn’t need to withhold any portion of the payment.
Contractors also enjoy zero additional benefits from the company they are engaged with. They are independently responsible for their own insurance and pension plans plus are typically not paid for any day that they do not engage in work.
2. Equipment
There are also differences between access to equipment and tools in order to complete the workload assigned. For employees, any piece of equipment needed to complete assigned tasks should be provided by their employers. In the event that specific tools are not available, the company is responsible for providing an allowance to the employee to purchase whatever is necessary or to reimburse the cost of the equipment after purchasing.
In contrast, the contractor is solely responsible for obtaining any equipment or tools they need to complete the task given to them. The business is also not responsible for reimbursing the cost of any additional equipment that needed to be purchased for the job, neither is it subject to providing any allowance.
3. Freedom and Autonomy
One of the easiest mistakes to make is relating to the differences in freedom and autonomy over work between contractors and employees. The differences are like night and day; however, companies still tend to overlook these distinctions, which can lead to some serious legal trouble. So, what kinds of freedom and autonomy do employees and contractors enjoy?
In general, employees are considered a part of the business that employs them. They are typically managed by a superior who has all the rights to control how and when the work gets done. Employees are entirely responsible for completing any tasks that have been assigned to them and are legally unable to delegate or subcontract their work to another person.
Conversely, contractors have a lot more freedom and autonomy over their work. The business has zero control over how the work is done and when it needs to be completed – except according to the pre-determined deadline – and, as such, contractors are free to delegate or subcontract tasks to other people. Contractors are totally independent of the company that they work with and are free to engage with other companies.
4. Tasks and Duties
In addition to the previous point, any and all tasks and duties given to employees and contractors carry obvious differences. As you may have guessed, since employees have less autonomy compared to contractors, there is no flexibility for those given to them. The tasks and duties that employees are responsible for will be clearly defined within their job description. However, any additional duties can be added at the discretion of their employer.
Contractors, on the other hand, are only required to carry out the services that have been outlined in an agreement, a contract or Scope of Work (SOW). SOWs make absolutely clear what tasks will be performed on a project and would typically include descriptions of deliverables, a timeline and any milestones to expect. They describe the needs of the project and outline how its goals will be met, and the contractor has no obligation to go above and beyond the services outlined within the agreed terms – unless they want to.
5. Risks
Regardless of the job, there are always risks attached to undergoing work – both minor and major ones. Another big difference between contractors and employees is who is in charge of providing protection from those risks. For employees, any risks faced by them while they are carrying out their duties are subject to legal protections under UK labour laws. The company is responsible for ensuring the health and safety of its employees and, thus, any costs incurred through injuries or other issues are burdened by the business.
Unless specifically stated within their service agreement, any and all risk faced by contractors when working is solely their own responsibility. They are responsible for their own insurance coverage, and in most cases, the business is free from fault should any issues occur while the contractor is engaged with it.
Legal Risks of Working With Contractors in the UK
Now that we understand the differences between who is classed as a contractor and who is considered an employee of a company, it’s understandable if solely engaging with a team of contractors is starting to sound more attractive. But before you jump the gun, you should be aware that there are very strict labour laws which cover employing contractors in the UK. So, before you make the decision to hire an independent contractor, you should thoroughly understand the legal risks attached to engaging with contractors.
1. Misclassification
The biggest risk of working with contractors is misclassification. The UK has been cracking down on worker misclassification in recent years, and a result of this is the introduction of the amended IR35 law. The IR35 determines how contractors should be taxed, and the recent amendments place the responsibility on the business to determine the contractor’s IR35 status.
As we’ve mentioned before, the line between “contractor” and “employee” is rather easy to cross, despite the obvious differences outlined in the previous section. If the HMRC have any reason to suspect worker classification, the business will be subject to an audit. If the company is found to have classified their workers incorrectly, it will face huge consequences, which can include massive fines, paying any taxes owed (with interest!) and even severe legal action.
2. Mismanagement
It is rather understandable that there is always the temptation to micro-manage any work that needs to be done. However, this should be avoided at all costs when engaging with independent contractors. Contractors are solely responsible for performing the services that they’ve agreed to, which would have been outlined within their engagement contract. As soon as the agreement is signed, it is completely up to the contractor how they wish to carry out their tasks and clients are explicitly not allowed to interfere.
If businesses overstep and start to mismanage the work tasked to the contractor by taking too much control, they run the risk of misclassification. Remember: there should be a clear divide between a company’s employees and the independent contractors they engage with. With a lack of attention and mismanagement, that fine line between the two worker statuses can be easy to cross without realising it.
3. Security Risks
Since independent contractors are responsible for sourcing their own equipment to complete their work, this could place many security risks on the company’s assets. If the contractor is unfamiliar with any of the company’s security protocols, even the smallest detail, engaging with them could expose systems to breaches or damage. There is also a risk of sensitive information being leaked – whether intentionally or otherwise – putting a great risk on a company’s reputation, too.
Engaging with contractors also places a risk on a business's intellectual property (IP). While most employees tend to sign away any rights when agreeing to employment with a company, it’s much harder to do so with contractors. Some contractors will request to retain their own IP rights, namely, attaching credit to the work that they’ve done for the company. This greatly complicates any attempt at protecting the company’s intellectual property – putting it at risk.
4. Permanent Establishment Risk
The term "permanent establishment risk" is used to describe the potential legal implications of a company having a physical presence in a foreign jurisdiction. For example, hiring employees in a foreign country can result in a permanent establishment, while hiring an independent contractor there can result in the same financial responsibility. This becomes especially problematic since there are many countries in the world that do not have a clear distinction between “employee” and “contrator” – with some of them considering the two one and the same.
Whether a foreign company wishes to engage with a British independent contractor or a UK company seeking to partner with contractors abroad, the legal status of the company may be unclear. This uncertainty puts the company at risk of being charged taxes in foreign jurisdictions, despite not having any legal entity in those countries.
How to Avoid These Contractor Risks
If it now seems a little daunting to pursue engaging independent contractors, you shouldn’t take the idea off the table just yet. There are very clear-cut ways for companies to avoid the contractor risks we’ve mentioned in the last section.
1. Put it in writing
One of the easiest ways to avoid misclassification is to also outline the service period between the company and the contractor. A contract is the only legally binding thing between a contractor and the business they are working with. The business relationship between the two parties must be clearly defined alongside the agreed-upon expectations from both sides on the project at hand. Expectations include deliverables, expected costs, a general timeline (defining the length of the project) complete with any milestones and deadlines, plus the agreed method of payment.
While a verbal agreement is indeed less fussy, having everything on paper and signed reduces contractor risk – and makes the relationship legally binding. That way, the company is clear on what they will receive and when they can expect it, the contractor can feel financially secure and there is legal documentation outlining the business relationship should there be a government audit.
2. Engaging with incorporated contractors
One way to greatly reduce the likelihood of facing misclassification risks is to only engage with contractors with their own incorporated business. This is much more desirable than working with sole proprietors as the business would then enter a more traditional B2B relationship in the eyes of the law.
Working with an incorporated contractor adds an extra “legal barrier” between the company and the contractor. Since the company would be paying the contractor’s corporation, of which is the legal employer of the contractor, there is a great reduction of contractor risk in terms of misclassification.
3. Partner with an outsourcing company
A good way to mitigate the legal risks that we’ve described in this article is to partner with a talent outsourcing company. These could either be an employer of record (EOR) or a professional employer organisation (PEO). This reduces contractor risks in a similar vein to engaging with incorporated contractors but with the added benefit of guaranteed compliance.
Engaging with a global EOR or PEO would provide even more benefits to the company that they partner with. Global EORs and PEOs give the added benefit of gaining access to a global talent pool – all while maintaining compliance – allowing a business to find just the right person for the job at hand or even on a more long-term basis.
For more information on how to work with freelancers or contractors safely, check out our 5 tips for keeping your project compliant.