What is a Contractor?

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.

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.

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. 

Key Characteristics of a Contractor:

• Self-Employment: Contractors are typically self-employed or work through their limited companies, giving them a sense of autonomy and control over their work.
• Project-Based Work: Contracts often revolve around specific projects, allowing flexibility and variety in their work assignments.
• Tax and National Insurance: Contractors are responsible for handling their tax and national insurance contributions, making it essential to manage their finances efficiently.
• IR35 Legislation: Understanding IR35 legislation is crucial for UK contractors, as it determines tax implications and employment status based on the nature of the engagement.

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.  

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: 

1. 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.‍

2. 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. 

3. They can get a replacement

‍Unlike employees, contractors aren't required to perform their work duties personally.‍

4. 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.‍

5. 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.

Difference Between Contractors and Employees

Understanding the distinctions between contractors and employees is crucial for businesses and individuals hiring or working in these capacities. Let's explore the fundamental differences between contractors and employees.

Employment Relationship:

Contractors:

• Contractors are typically self-employed individuals or business entities with a separate legal status.
• They maintain an independent business relationship with their clients and are not considered employees of the hiring company.
• Contractors often work on a project-by-project basis or for a specific duration outlined in a contract.

Employees:

• Employees have a formal employment relationship with the company they work for.
• They are subject to the company's policies, procedures, and management oversight.
• Employees typically have a permanent or long-term relationship with the company and work regular hours as defined by the employer.

Tax and Benefits:

Contractors:

• Contractors are responsible for managing their own taxes, including income tax and self-employment tax (if applicable).
• They do not receive employee benefits like health insurance, retirement plans, or paid time off from the hiring company.

Employees:

• Employees have taxes withheld from their paychecks by the employer, including income tax, Social Security, and Medicare taxes.
• They are often eligible for benefits such as health insurance, retirement plans, paid time off, and other perks offered by the employer.

Control and Autonomy:

Contractors:

• Contractors have more autonomy over their work, including how, when, and where they perform their services.
• They are responsible for managing their schedules and deciding on the methods to complete the tasks outlined in the contract.

Employees:

• Employees work under the direct supervision and control of the employer.
• Employers dictate the work hours, location, and methods of work for employees to ensure tasks are completed according to company standards.

Legal and Liability:

Contractors:

• Contractors are often liable for their work and any errors or omissions that may occur during the project.
• They typically carry their own liability insurance to protect themselves and their clients.

Employees:

• Employers are generally responsible for the actions of their employees during the course of their employment, and they carry liability for employee actions.

1. Flexibility and Autonomy:

As a contractor, you have the freedom to set your work hours, choose your projects, and decide where you work. This flexibility allows for a better work-life balance and the ability to tailor your schedule to suit your needs.

2. Diverse Project Opportunities:

Contractors often have the opportunity to work on a range of projects across different clients and industries. This diversity can enhance your skill set, knowledge, and overall professional growth.

3. Higher Earning Potential:

Contractors can often charge higher fees for their specialized services compared to salaried employees. With efficient financial management and a steady stream of projects, you can significantly increase your income.

4. Tax Advantages:

Contractors can benefit from various tax deductions that may not be available to traditional employees. These deductions can include business expenses, home office costs, and travel expenses related to work.

5. Business Ownership and Branding:

Working as a contractor allows you to operate as a business entity, which can enhance your brand and professional image in the industry. You can build a portfolio of successful projects and establish yourself as an expert in your field.

6. Skill Development and Learning Opportunities:

Contracting often exposes you to different clients, industries, and technologies. This exposure provides continuous learning opportunities, helping you stay updated with the latest trends and advancements in your field.

7. Networking and Industry Connections:

Working on various projects allows you to build a broad network of professional connections. These connections can lead to more project opportunities, collaborations, and partnerships that can further advance your career.

8. Independence and Decision-Making Authority:

Contractors have the authority to make decisions related to their projects without the need for extensive approvals from higher-ups. This independence allows for quicker decision-making and streamlined project execution.

Contractors play a vital role in the modern business landscape, providing several advantages that businesses find valuable for their operations and growth. Let's delve into the reasons why businesses often choose to work with contractors.

1. Flexibility in Workforce:

• Businesses can adjust their workforce according to project demands by hiring contractors for specific tasks or projects. This flexibility allows for efficient resource allocation and cost management.

2. Access to Specialized Skills:

• Contractors are usually experts in their respective fields and offer specialized skills that businesses may not have in-house. This enables businesses to access a wide array of expertise without the need for permanent hires.

3. Cost-Efficiency:

• Employing contractors can be cost-effective for businesses as they often do not require benefits like health insurance, retirement plans, or paid leave. Businesses can save on overhead costs associated with full-time employees.

4. Scalability and Scalable Growth:

• Contractors can help businesses quickly scale up or down based on project needs or business growth. This agility is particularly advantageous in industries with fluctuating demand.

5. Meeting Short-Term Needs:

• Businesses use contractors to address short-term or temporary needs, ensuring that the required skills and resources are available to complete specific projects without a long-term commitment.

6. Reduced Legal and Administrative Burden:

• Hiring contractors often involves less administrative work and legal responsibilities compared to hiring full-time employees. This simplifies the hiring process and allows businesses to focus on core operations.

7. Focus on Core Competencies:

• By outsourcing certain tasks to contractors, businesses can concentrate on their core competencies and strategic objectives, leveraging the contractor's expertise for non-core activities.

8. Risk Mitigation:

• Employing contractors can mitigate certain risks associated with employee-related liabilities, such as workers' compensation, unemployment claims, and potential legal disputes.

9. Special Projects and Expertise:

• Contractors are often hired for specialized projects that require specific expertise or skills that the business may not possess internally. This ensures high-quality results and successful project completion.

Do your research 

The first step you’ll need to do is to conduct in-depth research, and think through various important factors—from finances and tax implications, to lifestyle and business opportunities—to ascertain if becoming a contractor is the right decision for you.

The following are factors and questions you should consider:

• Would the benefits (e.g. increased flexibility) outweigh the downsides (e.g. lower job security)?
• Will you be comfortable with navigating all kinds of work challenges on your own? How will you remain motivated to seek out new job opportunities constantly?
• Are contractors in demand in your field of work? How much do these contracting jobs pay?
• What is IR35?
• What are the tax implications of contracting?

Decide on a business structure

Sole trader, limited company or umbrella company?

We understand that it can seem incredibly confusing and complex, so we’ve tried to keep our explanation simple and easy-to-understand. 

In our guide on contracting, we break down the pros and cons of each option.

Below, we've included a brief overview of our recommendations:

• Sole trader or self-employed: Best for small projects outside of a regular PAYE role
• Umbrella company: Best for contractors who want to keep things really simple and earn a regular PAYE income.
• Limited company: Best for projects outside of IR35, invoicing multiple clients easily and tax efficiency.
  

Develop a business strategy

“If you fail to plan, you’re planning to fail”— an oft-quoted statement by Benjamin Franklin certainly rings true for anyone who sets out to become a contractor or run their own business. 

While strategic planning is not set in stone, working out a plan is still helpful, as it is a way for you to consider multiple perspectives, identify potential opportunities and pitfalls and conceptualise back up plans you could fall back on.

Here a few questions to guide you through the process of writing a business plan:

• What need are you addressing, and who is your target audience?
• How much will you charge for your services?
• How will you get the word out about your business?
• Where will you find clients and job opportunities?
• What’s your process for convincing clients to hire you?
• What do you need to get started? 

Additional resources:

• Inc.'s guide to writing a business plan
• Entrepreneur.com's guide to starting a consulting business
• Entrepreneur.com's guide on creating a one page business plan

Get your business finances and insurance sorted out

As a first-time contractor, it’s important that you get the following sorted out:

• Set up a business bank account 
• Register a company (if you decide to go down the limited company route)
• Determining the level of accounting support you need. You may consider DIY accounting software or subscribing to monthly accounting packages tailored for contractors.
• Invest in business insurance, such as professional indemnity insurance and public liability insurance 
  

We’ve written up a separate article on how to become a contractor, which covers additional points such as how to register a limited company, VAT, tips for expanding your network, platforms for finding opportunities and more.

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