Compliantly Engage Contractors in the United Kingdom

The United Kingdom government is undergoing leadership change that is widely expected to impact the tax policies of the HMRC (Her Majesty’s Revenue & Commission). As described in greater detail below, the primary tax legislation impacting engagement of freelancers in the UK is known as IR35. The current version of the IR35 rules, which went into effect April of 2021, have been the subject of much discussion and political positioning by PM candidates. It is widely expected that the latest premiership will pursue some form of legislative change to IR35, ranging from a potential repeal to a major rewrite of the legislation.

Worksuite recognizes the impact this political uncertainty in the UK has on our customers and the UK-based talent communities they entrust to our platform. When new rules or laws go into effect, whether it be in the UK or any of the 150+ countries we support, Worksuite customers can rest assured our compliance products and services will be up-to-date, providing you the protection and confidence you need to engage talent anywhere.

Any business hiring in the UK should understand the important legal distinction between who classifies as an independent contractor and who can be hired as an employee. Fines or penalties may be issued to businesses hiring contractors under the guise of employment. 

Understanding the distinctions between employees and independent contractors (or self-employed workers) is critical to compliantly engaging workers in the UK. It is essential to work with a partner like Worksuite to ensure you put in place an engagement framework that accurately classifies freelancers as independent contractors for you and lets you know when freelance talent must be engaged as a payrolled contractor or employed directly. 

In the UK there are multiple sources of employment law that cover both employees and independent contractors. UK employment law may also vary slightly between its four geographical zones of Great Britain (England, Scotland, Wales) and Northern Ireland.

In the UK, an individual is classified as an independent contractor or an employee based on the reality of the relationship between the individual and the hiring company. There is no single body of law in the UK that specifies this distinction. Instead, multiple factors are considered. Individuals are generally considered to be independent contractors if they:

• Are described as a contractor in the contract itself.
  
• Can be (or are expected to be) dismissed once the contracted work is complete.
  
• Can refuse to perform a task (unless that task is part of their contract).
• Are paid for a specific project or task, rather than on a recurring basis.
• Are not entitled to a minimum amount of work or a minimum amount of pay.
• Are not listed on the hiring company’s normal payroll.
• Are subject to relatively little control by the hiring company, such as when, where, and how they complete their tasks.
• Are not performing a core business function or operation.
• Have a right to substitute another contractor to perform the work (such as a subcontractor or the individual’s own employee).
• Have a right to work for another client or competitor at the same time (so long as this is not prohibited by the contract or an NDA).
• Are not entitled to benefits (sick leave, maternity/paternity leave, etc).
• Do not have their income tax withheld from their payment; they file their own tax returns.

Sole traders and PSCs: In the UK, independent contractors typically either operate as a self-employed “sole trader” or they create a “personal services company” (PSC) such as a limited liability partnership (LLP) or public limited company (PLC). For companies looking to hire an independent contractor, hiring an individual who is working as a “sole trader” can be risky, as it is possible the relationship may become an employer-employee relationship, which places additional financial and legal obligations on the employer. Instead, it can be less risky to work with an individual who is operating as a PSC.

IR35 rules (named after an Inland Revenue (IR) press release from 1999) were introduced to prevent contractors from working “off payroll” as a way of avoiding tax and national insurance contributions. IR35 tries to ensure that when contractors are effectively working in the same manner as employees, those contractors pay the same national insurance and income tax contributions as employees.

IR35 rules apply when a contractor provides services to a client via an ‘intermediary’, such as their own company, a partnership, or a personal service company (PSC). The IR35 rules were originally introduced in April 2000, but changes in April 2021 placed greater responsibility on medium and large-sized companies (along with public sector organisations) to assess the contractor’s employment status. 

There are several aspects of IR35 that are worth noting:

‘Inside’ vs ‘Outside’ IR35: A contractor can be ‘inside’ or ‘outside’ IR35. Being ‘inside’ IR35 means the contractor is working within the remit of the powers of IR35. In short, the contractor is subject to the same income tax and national insurance contributions as if they were an employee. If a contractor is assessed as being ‘inside’ IR35, they may also be able to benefit from employee rights. Being ‘outside’ IR35 means the IR35 rules do not apply. The contractor can pay themselves a salary, plus further dividends which are exempt from national insurance contributions.

A contractor who is ‘inside’ IR35 will typically:

• Not have their own professional business identity or branding
• Be paid on a regular schedule, not on a per-project or task basis
• Receive employee benefits (such as sick pay)
• Use the client’s equipment, rather than their own 
• Work at the client’s site, rather than their premises
• Work for a single client for a long period, rather than multiple clients in parallel
• Personally carry out and deliver the contracted work/tasks, rather than substituting another person (e.g., a subcontractor) to perform the work
• Be closely supervised by the client, with little control over when or how the work is performed
• Not expend any personal costs to fix or correct faulty or subpar work

Check Employment Status for Tax (CEST): The CEST tool provided by HMRC allows a hiring company (or a contractor themself) to perform an employment status assessment. The tool can be used to understand (a) if the IR35 rules apply to a contract, and (b) if a particular piece of work is classed as employment or self-employment. The tool runs through a series of questions, whereby each response affects the subsequent questions that are asked. The questions can include (as of April 2022):

• Has the worker ever sent a substitute to do this work?
• Does your organisation have the right to move the worker from the task they originally agreed to do?
• Does your organisation have the right to decide how the work is done?
• Does your organisation have the right to decide the worker’s working hours?
• Will the worker have to buy equipment before your organisation pays them?
• How will the worker be paid for this work?
• If your organisation was not happy with the work, would the worker have to put it right?
• Will you provide the worker with paid-for corporate benefits?

IR35 rules apply to an individual contract. This means that a contractor may undertake some contracts that are ‘inside’ IR35 and some contracts that are ‘outside’ IR35. 

There are two primary engagement models for working with independent contractors in the UK.

A. Direct engagement

Direct engagement of the worker as self-employed or registered via their own limited company. To facilitate direct engagements, there are two general types of contracts to use with independent contractors:

• Work Contract. Under a work contract, the contractor is required to deliver a piece of work or a certain outcome in exchange for a one-off fixed remuneration. Each contract relates to the delivery of a single ‘work’. The contractor bears the risk under this contract and is obliged to fix any errors or other defects until the contractual specifications of the work are achieved. 
• Service Contract. Through a service contract, the contractor provides services to the client during a defined period of time and under certain conditions – all of which are detailed in the contract. The contractor bears no risk if the services provided do not ultimately achieve what the client had wanted, so long as the services meet the requirements of the contract.

B. Umbrella company

These firms come in two forms, and both are specially designed to vet and engage freelancers compliantly as either contract employees or independent contractors on your behalf.

The contractual relationship is between the umbrella company and the client, with the umbrella company running payroll and administration for the contractor. The umbrella company invoices the client directly while paying the contractor via PAYE as a standard employee. Umbrella companies levy a fee on the contractor to cover their costs.

• Staffing agency. Here, the hiring company engages with a staffing agency, which in turn supplies one of its own contractors to deliver the contracted services. The hiring company pays the staffing agency directly, in accordance with the terms of the contract with the agency. The agency will pay the independent contractor through a separate contractual arrangement. Under this model, the contract is between the hiring company and the staffing agency. 
  
• Hiring partner. The hiring company can also work with a hiring partner who helps them vet potential independent contractors, set up contracts, ensure the contractor is properly classified, onboard and manage contractors, and pay contractors. 

In the UK, independent contractors must pay tax on all income above £12,570 (for the 2022/23 tax year). Independent contractors manage their own tax payments to HMRC, typically via the Self-Assessment process. Depending on their level of self-employed income, independent contractors might need to register to pay Value Added Tax (VAT). Unlike employees, independent contractors do not need to pay Class 1 National Insurance Contributions (NICs). However, they do need to pay Class 2 and Class 4 NICs.

It is important to note that an individual’s employment status (as an employee, contractor, or worker) does not necessarily determine their tax status. In the UK, these determinations are made by an employment tribunal and a tax tribunal (or HMRC), which are separate. One decision may influence the other, but this is not guaranteed.

We can simplify hiring full-time workers in the UK by acting as the Employer of Record (EOR) on your behalf, handling everything from contracts, onboarding, documentation, payroll, benefits, and workforce management. Reduce your time-to-hire by 90%, slash your overheads, and remain fully compliant.

• Quickly find, hire, and onboard talent in the UK without setting up your entity
• Prevent expensive legal, contractual, or tax mistakes
• Manage contracts, payroll, and global tax forms all in one Worksuite