What is a Contractor?

Chris Andreou

June 3, 2021

what is contractor guide

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Introduction

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 contractor 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. 

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Contractor 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.  

Contractor sitting down at a table looking at phone

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.

How to become a contractor

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:

Get your business finances and insurance sorted out

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

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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What's Inside:

  • What is a Limited Company
  • 10 step process for setting up a Limited Company
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What's Inside:

  • What is a Limited Company
  • 10 step process for setting up a Limited Company

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Employing contractors

There are a few steps you'll need to consider with hiring contractors. These include:

  • Sourcing for contractors
  • Assessing contractor CVs
  • Interviewing a contractor
  • Payments
  • Contract terms
  • Terminating a contract
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How do I register a limited company?

There are a couple of ways to go about registering a limited company:

  • Register directly through Companies House
  • Go through a third party: An accountant or company formation service can help you process your application, significantly lessening your admin burden. Beyond the application, a good third-party service can also provide accounting advice, help you fulfil your filing obligations and assist with other admin tasks.

We've included further details in our guide on setting up a limited company.

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How to Start Contracting Guide

  • What is a contractor
  • Types of contractors
  • Contractor business structures
  • Contractor accounting
  • Understanding IR35
  • Contractor insurance
  • Banking for contractors
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What is subcontracting?

As an independent contractor, there may come a point in time where you need to consider subcontracting-you might decide to take on work as a subcontractor, or hire a subcontractor for your projects.

Whichever option you're exploring, how do you decide if the benefits truly outweigh the cons? And are there important tips you need to keep in mind?

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5 advantages of a limited company

The advantages of operating as a limited company are well known. It can be a great way to maximise your take-home pay, improve your credibility with customers and limit your personal liability. Like most things in life, it's a case of what's best for your situation. While the positives outweigh the negatives for most people, there are a few things you should know before you make the jump to a limited company.

In this article, we'll outline the disadvantages of operating as a private limited company. Bear in mind that there are many advantages to a limited company and in many cases, these advantages will outweigh the disadvantages, so don't think of this as a report of doom and gloom.

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What are Personal service companies?

While there isn't a legal or formal definition of the term, personal service companies (PSC) refer to limited companies that are owned by a contractor, who is also the only shareholder and sole director. In some instances, the company may also be owned by a very small group of individuals.

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What are the different types of contractors?

There are different types of contractor jobs available across diverse sectors. Contractors may be hired to perform services such as:

  • Marketing
  • IT maintenance and support
  • Graphic design
  • Recruitment
  • Business development
  • Catering
  • Construction work
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What are the advantages of a Limited Company?

The advantages to setting up a limited company are:

  • Owners aren't fully liable
  • Tax savings
  • Using a limited company structure lends credibility to your business
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What is an independent contractor?

An independent contractor is an individual who is engaged in a work agreement with a company or entity as a non-employee.

Factors that identify an independent contractor are:

  • They have a greater degree of control over their work
  • They offer a special skill set
  • They are able to get a replacement
  • They aren't entitled to employment benefits
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How do I register my business?

To register a business as a sole trader, you need to:

Once you've registered, you need to fulfil your responsibilities as a sole trader. These include:

  • Keeping records of your sales and expenses
  • Submitting a Self Assessment tax return each year
  • Paying income tax and National Insurance Contributions

To set up a limited company, you need to:

  • Decide what type of limited company you need
  • Choose a business name
  • Choose how to set up your limited company
  • Complete the company formation process
  • Open a business bank account
  • Inform your stakeholders
  • Get your VAT registration or transfer sorted out
  • Set up your payroll
  • Update your company details
  • Get your books sorted out

To set up a business partnership, you need to:

  • Choose a business name
  • Choose a ‚Äònominated partner'
  • Register with HMRC
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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.

Read Full GuideRead Full GuideCalculate Now

Download Now:

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Is a contractor self employed?

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.

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Key considerations when you register a Limited Company

As a freelancer, contractor, or small business, it is typical to start with the simple structure of operating as a Sole Trader.

While taxes and other administrative work may be relatively easy when you are a Sole Trader, as your volume of business goes up, there are more and more reasons to take on the task of becoming a Limited Company.

For instance:

  • A Limited Company protects your personal assets. If you are found liable in a lawsuit, only your business assets are at risk.
  • A Limited Company is usually more tax efficient than being a Sole Trader.
  • Once you have your name chosen as a Limited Company registered through Companies House, no one else can take your company name.

Luckily, running a Limited Company doesn't have to be exceedingly complex, though following a set plan will help to keep the complexity to a minimum.

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What type of business structure is best for you?

If you're looking to the future with the hopes of beginning a journey running your own startup, chances are you're feeling some mixture of excitement, trepidation, and uncertainty when it comes to the finer details of your plan.

Starting your own business is an immensely fulfilling process and an excellent means to flex your creative muscles, but there's a lot of humdrum of business behind the process of turning a vision into a dream.

One of the most important (and one of the earliest) decisions in this process will centre around your business's formation. You'll have to select which type of business structure best suits your goals for the future.

While the choice may sound easy, you'll be well-served by giving the decision ample consideration. The business structure you select will have measurable implications on the way you make money and do business. It'll impact:

  • How much tax you pay
  • Your degree of personal liability should the business fail
  • How much administrative work is involved in the business (both before it comes to fruition and over the course of its life)
  • Your ability to finance and fund your efforts

If you make the wrong selection when it comes time to choose a business structure, you could be faced with a myriad of complications in the future.

Paying professionals for guidance and advice once things go wrong is costly and, for many, an embarrassing affair-performing research well in advance will ensure you're making the best choice for your company and that you can avoid losing out on money or pride later on.

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How do I set up a Limited Company?

To set up a limited company, you need to take the following steps:

  • Decide what kind of limited company you need
  • Choose a business name
  • Choose how to set up your limited company
  • Complete the company formation process
  • Open a business bank account
  • Inform your stakeholders
  • Get your VAT registration or transfer sorted out
  • Set up your payroll
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How do I become a contractor?

To become a contractor, you need to:

  • 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.
  • Decide on how you'll operate: As a contractor, you may operate as a sole trader, through your own limited company, or work with an umbrella company or recruitment agency.
  • Develop a business strategy: Strategic planning isn't set in stone-but 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.
  • Get your business finances and insurance sorted out: Setting up a business bank account, registering a company, determining the level of accounting support you need and investing in business insurance are important aspects you need to sort out before you begin contracting.
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What is a contractor?

A contractor is a professional that provides skills and services to a specific client under set terms. The terms can be for a set number of hours, a certain time frame or duration of a project.

A contractor is responsible for their own dealings and has discretion over the work they carry out.

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What are the disadvantages of a Limited Company?

The drawbacks to setting up a limited company include:

  • There are additional filing and reporting requirements to adhere to.
  • Reduced privacy
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Guide to employing or hiring contractors

You have an important project at hand, and you require a contractor's specialist knowledge to fill in the skill gap in your team. You're ready to hire-except that you're unfamiliar with the hiring process.

If this is your first time hiring a contractor, our article will guide you through the essentials.

We'll cover the following:

  • Sourcing for contractors
  • Assessing contractor CVs
  • Interviewing a contractor
  • Payments
  • Contract terms
  • Terminating a contract
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How to set up a Limited Company

When you set up a limited company, you'll enjoy many advantages you don't get as a sole trader. Not only is it a tax-efficient way to run your business, it's also a great way to limit your personal liability and increase your credibility with customers. Additionally, it could open new avenues of work that wouldn't be open to you if you were operating as a sole trader, especially some contractor roles.

One of the disadvantages of running a limited company is that it involves a lot of paperwork, but with the help of this guide, we'll clear away the jargon and tell you exactly what you need.

If you're unsure about whether a limited company is right for you, check out our handy article comparing the differences between Limited companies and Sole Traders to see which business entity is right for you.

If you've got more important things to do than dealing with extra admin, you can always take advantage of one of our accountancy packages and we'll do all the forms and applications for you.

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