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Self-employment as an independent contractor is a popular income model for many individuals. The Covid pandemic has prompted an even greater increase in UK individuals working as self-employed independent contractors. 

UK labor law distinguishes between three types of employment status classification: employee, independent contractor (or self-employed), and worker. Depending on the individual’s classification, this can have significant implications for companies looking to hire contractors in the UK. For the hiring company, engaging with independent contractors may be legally and financially risky, especially given the possibility of an independent contractor becoming re-classified as an employee of the hiring company.

This risk has been heightened since the UK updated the Off-Payroll Working (IR35) rules in 2021. Hiring companies should ensure their contract templates fully align with IR35, so that the individual’s status as a contractor is clear.

If the real substance of the company-contractor relationship proves to effectively be an employment relationship, the hiring company may suffer legal and financial penalties (including payroll taxes). It is therefore important to leverage an employment service partner like Worksuite when hiring in the UK, in order to ensure that independent contractors fall under the correct working relationship with your business.

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.

Workers: In addition to “employee” and “independent contractor”, UK employment law also has a third category: “worker”. Individuals are generally considered to be workers if:

• There is a contract between the individual and the hiring party.
• The contract does not permit the individual, or the individual agrees not to, substitute another person for completing the work. 
• Both the individual and the hiring company are not in the same professional field, nor are they operating a business.

The “worker” category only exists within employment law; it does not affect tax law. There are only two categories under UK tax law: employed and self-employed.

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. 

Payment to independent contractors is flexible and can be determined by both parties within the contract. There are no laws in the UK that require a specific payment method or time of delivery, although the typical window for paying a contractor is 14 days or 28 days from the date of issuance of the invoice. When working with independent contractors, you’ll need to have an established process for paying them correctly and on time within the contract. 

There are four main types of contracting model for working with independent contractors in the UK.

Direct engagement

Under this model, the hiring company engages directly with the independent contractor and establishes a direct contract for the provision of services. The hiring company then pays the independent contractor directly, in accordance with the terms of the contract.

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. The contract is therefore between the hiring company and the staffing agency, while the agency pays the independent contractor through a separate contractual arrangement. 

Umbrella company

Due to the IR35 rules (see above), UK contractors often work through an umbrella company. This turns a ‘self-employed’ individual into a legal ‘employee’ of the umbrella company and therefore avoids the complications of the IR35 rules. 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.

Hiring partner

The hiring company can also work with a hiring partner who helps them vet potential 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 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.

It is mandatory to provide new employees with a written statement outlining the basic terms of employment which must include:

Compensation (in GBP)
Working hours
Annual leave
Sick pay
Severance pay
Notice period

However, it is common for employees and employers to negotiate a formal employment contract. Although most employment agreements are concluded indefinitely, fixed-term agreements are also possible.

Employers may request their employees to work a standard 48-hour week. Daily working time is flexible and varies depending on business needs but a nine to five working day is typical for most employees in the UK.

After six hours of continuous work, employees must take a 20-minute break.

All work above the standard working hours a week is to be paid as overtime and is regulated by employment contract/collective agreements etc. When an employee is requested to work overtime or work on holidays, employers may request this of employees in writing.

All overtime hours in excess of 48 hours a week are paid at an overtime compensation rate; this rate is stipulated in the employment contract/collective agreements. The hourly overtime rate cannot fall below the national minimum wage.

UK labour law does not regulate the length of probation periods. Generally, employers and employees usually agree on a probation period between three and six months.

The termination process varies according to the employment agreement and collective agreement in place and is based on the type of contract and reason for termination. Dismissals can be deemed fair or unfair depending on the reasoning and conduct of the termination.

Severance pay is only required in the case of redundancy. The amount of severance is dependent on the age of the employee, if they have served at least two years of service as follows:

• Half a week’s pay for each full year for employees under the age of 22
• One week’s pay for each full year for employees between the ages of 22 to 41 years of age
• One and half weeks’ pay for each full year for employees over the age of 41
• Length of service is capped at 20 years
• Weekly pay is capped at 540 GBP

The annual leave entitlement is 28 days of paid leave per year for full-time employees. Bank holidays are included in the annual leave entitlement.

Employers may offer additional leave at their discretion; this must be outlined in the employment contract.

Employees can receive up to 28 weeks of paid sick leave; this is compensated at 98.85 GBP per week Statutory Sick Pay (SSP) as a minimum, this is not payable for the first three days of any sickness absence. Employers may compensation varies depending on the company’s sick pay scheme.

If the employees’ sick leave exceeds seven days, including weekends and bank holidays, the employee must provide a professional medical doctor certificate.

An employee may also be entitled to contractual sick pay (that is, pay during sick leave at a higher rate than SSP) if the employer offers this benefit.

In the United Kingdom, female employees receive 52 weeks of statutory maternity leave, 26 weeks of ordinary leave, followed by 26 weeks of additional maternity leave.

An employee is not required to use the full 52 weeks of leave; however, the employee must take at least two weeks following the child’s birth; this may vary depending on the employee’s sector.

Mothers are compensated by Statutory Maternity Pay (SMP) for up to 39 weeks at the rate of 90.00% of the employees average weekly earnings for the first six weeks, and 151.97 GBP or 90.00% of the employees average weekly earnings, whichever is lower) for the following 33 weeks.

Employees are entitled to one to two weeks of paid paternity leave, which begins after the child’s birth. Employees receive Statutory Paternity Pay of 151.97 GBP, or 90.00% of the employee’s average weekly earnings, whichever is lower, per week of leave.

Parents in the United Kingdom may be entitled to Shared Parental Leave (SPL) when adopting a child or following the birth of a child. Shared Parental Leave allows parents up to 50 weeks of leave they can share; 37 weeks of pay is possible. Employees must take leave within the first year of the child’s birth.

Depending on the employment contract, an employee may be allowed additional leave, as approved between the employer and employee, for the following:

• Bereavement leave: In the UK in the event of the death of an immediate family member, an employee is entitled to bereavement leave of up to three days (the employment contract will stipulate whether this is paid or unpaid leave).
• Jury Service Leave: Employers to provide their full-time regularly employed employees, job-protected, unpaid leave for their duty as jurors or as a witness in a case, or acting as a plaintiff or defendant in the courts. Employees must provide a copy of the jury summons to the employer as evidence of requirement.  The court will provide a specific amount of payment and the employer can choose to provide any additional payment.
• Public Duties Leave: Employees are entitled to a reasonable unpaid amount of time off to perform public duties, for example, if they are:
• a magistrate (also known as a justice of the peace)
• a school governor
• a member of any statutory tribunal
• a member of the managing or governing body of an educational establishment