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Understanding the basics: What is a contractor?

We’ll explain what it means to be a contractor, plus how it differs from full-time employment and types of business structures

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January 14, 2020

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You’ve been thinking about making the leap from employee to self-employed. If contracting is one of the options you’re considering, this article is for you. We’ll run you through the basics, including what it means to be a contractor, how it differs from full-time employment and the type of business structures that contractors typically choose.  

What is a contractor?

Contractors are self-employed individuals who provide services to a business. Generally, they’re highly skilled, and are hired for projects that require specialist skills or to bolster a team during busy periods.

Types of employment

Contractors can be self-employed, a worker or an employee. Those who are employed through an umbrella company or an agency could be considered a worker or an employee. If a contractor is a sole trader or runs a limited company, he or she will then be considered a self-employed person. If you needed more information about the different types of employment status, here’s a quick recap: 

  • Employee: Employees have an employment contract, are provided with regular work and enjoy employment rights. They obtain a salary and benefits, and their employer makes deductions for PAYE and National Insurance Contributions from their salary. 
  • Worker: Workers perform casual or irregular work for a business, and their contracts typically include terms like ‘casual’, ‘as required’ or ‘zero hours’. PAYE and National Insurance Contributions are deducted from their salary, and they enjoy some employment rights. 
  • Self-employed: Freelancers, sole traders, limited company directors and contractors are considered self-employed individuals. They run their own businesses, and are responsible for its success or failure. These individuals aren’t paid through PAYE, and don’t enjoy employment rights that employees are entitled to. 

Business structure

Contractors typically trade as a limited company, or work through an umbrella company. There are several factors you’ll need to take into consideration when deciding on a company structure that works best for you. This includes whether your contracts will likely fall within the IR35 rules, if you plan to work as a contractor temporarily or for the long run, and if you think you can commit to the paperwork and time spent on accounts required of limited company directors. 

It can be complex, and you need to understand the IR35 legislation. If you need personalised advice, a specialist contractor accountant will be able to guide you through your decision-making process.  

what is a contractor?

Factors that identify a contractor

If you were to make comparisons between a contractor and a full-time employee working within the same company, you’ll find that there are several distinct differences between them. 

These are: 

  • Contractors have a greater degree of control over their work: There are a couple of tests to distinguish an employee from a contractor. The first is the ‘how, what, when and where’ test. As the name suggests, the test identifies a contractor based on whether he or she is instructed on how to complete a task, what tasks to perform, when the tasks should be done and the location it should be completed at. An employee will be provided specific instructions across these factors; in contrast, a contractor has the freedom to make his or her own decisions. The second test is the mutuality of obligation. This refers to the obligation of an employer to provide work and make payment for it, and the obligation of the employee to accept the work. This doesn’t apply to contractors - while the client may offer a contractor additional work after a project is completed, the contractor isn’t obliged to accept it.
  • They offer a special skill set: Contractors are best known for their specialist skills, and are typically brought into the company to fill in a skill gap that employees are lacking in. 
  • They can get a replacement: Unlike employees, contractors aren’t required to perform their work duties personally.
  • They enjoy tax advantages: Contractors operating through a limited company typically draw a low salary, and draw the remainder of their income through dividends. This is a more tax efficient way to operate, as neither the company nor the contractor (as an employee) are required to pay National Insurance Contributions on dividends.
  • They aren’t eligible for employment benefits: Contractors are generally not entitled to company benefits that full-time employees enjoy, and don’t get holiday or sick pay when they’re not working. However, if you’re in the scope of the Agency Workers Regulations (AWR), you’ll be entitled to certain rights in line with those of full-time employees, such as paid annual leave, equal pay and automatic pension enrolment. For more information on AWR, check out the Gov.uk website or guide.

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