What is a Contractor?

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

1. Employee

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 are supervised and obliged to do the work that you are contracted to do. Employees have employment rights.

2. Worker

As a Worker where you work on a temporary basis, usually as an Agency Temp or a Casual Worker (short-term contracts) but you also have PAYE Tax and NI contributions deducted from your pay by the Employer. Workers have some employment rights.

3. Self-Employed

As a Self-Employed person – you can be called a Freelancer, Sole Trader, Contractor or Limited Company. The self-employed have very few employment rights at present.

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).

- Self-Employed (if they are 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 are supervised and are told what times to start and finish work, what to do). Temps are eligible for holiday and sick pay. From October 2011 they will be, in most circumstances, eligible for ‘equal treatment’ under the new Agency Worker Regulations.

- A Contractor, however, is responsible for their own ‘business’ dealings and has control of how and when they do their work. They would either be employed through an Umbrella Company for the purpose of paying them (and paying their taxes), have their own Limited Company or be 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.

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 do not take on – they are not obliged to accept a contract. This is called ‘Mutuality of Obligation’. In an employment contract 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 is 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 does not 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 cannot be defined by the client.

- While Employees are paid for the hours they work, Contractors are paid on completion of specific ‘milestones’, which should be defined in the contract.

- 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 are not (however, this will change when the Agency Workers Regulations that come into effect on 1st October 2011).

- Have no redress if the Client terminates or chooses not to renew the contract. The contract should clearly set out the way in which termination will be handled and either party can terminate the agreement immediately if a breach of contract has occurred.

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 the Sole Trader, so Contractors were forced to set themselves up as their own Limited Company as the Agency does not have liability to 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 a variety of factors, including whether or not your contracts are likely to fall within the IR35 rules. It is therefore vital that you understand what IR35 means.


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