This is one of the common questions I get from entrepreneurs, which is totally understandable. I mean it’s a big decision and there are pros and cons for hiring both. So, it’s worth taking the time to figure out which is best for your business 👏
In law, the type of employment is referred to as the employment status i.e. a contractor or employee. And it’s worth knowing upfront that your decision on the employment status does have tax implications (and we all know HMRC doesn’t like it when people try to avoid tax, even when it’s not on purpose) 🚫
So, to help you along here’s the important things you need to know!
HIRING AN EMPLOYEE – HERE ARE THE PROS!
Here’s my take on why you would hire an employee:
✅ You're in Control - You get more control over when, how and where they do the work. So, if you want to hire someone to work every Tuesday 2pm to 4pm from your office or you think of something you need to delegate, you can flex their job. And you can do things like stating they must work exclusively for you. There’s significantly less control with a contractor – as they are just providing a service to you.
✅ Commitment is both ways - With an employee, you have someone fully dedicated to your business. Whereas when a Contractor finishes an assignment, they might not be available the next time you need them if they have other projects. You’ll likely have them with you for longer than a contractor (especially if your contractor has big ambitions for their own business). Generally employees are happy to exchange their hard work for a salary and want job security (otherwise they would be working for themselves too).
✅ The standards are set by you - You can train and mould them to do things the way you want them done. You can give them feedback, performance objectives and training to ensure you are happy. A contractor may have their own way of doing things.
✅ Flex Appeal - Despite the commitment, you can have different types of employment contracts, such as part-time (work a set number of hours per week or month) or fixed-term (working for a set period of time, like covering maternity leave or for a project)
BUT THERE’S A DOWNSIDE (SOME CONS)
But it’s not all plain sailing… 🤔
❌ There's baggage - And by baggage, I mean, employees have a lot of employment rights and entitlements that you don’t get with hiring a contractor. I’m talking holiday allowance, minimum wage requirements, sick pay and redundancy pay. Plus, a lot more.
❌ It ain't cheap – You’ll likely pay a lower hourly rate than a contractor, but you’ll have to offer a pension, training, benefits, sick pay (all those rights I mentioned above). You’ll also need to pay national insurance, more tax than contractor and invest in things like employers liability insurance and PAYE systems to pay them, which all add up.
❌ It’s a big commitment – You’ll have to pay their salary each month, regardless of how much money you make. So, you need to be confident that you can afford this. If you want to let the employee go, you need to have a good reason as the laws of England are very clear on this. The redundancy process or poor performance dismissal process need to be followed properly.
If you're thinking this might be the best option for you, check out my book on how to hire your first employee.
HIRING A SELF-EMPLOYED CONTRACTOR
Now let’s talk about Contractors / Self-employed Freelancers. Here are the pro's
✅ Expertise at your fingertips - Freelancers, consultants and contractors are usually an expert at what they do, so should be quickly to get up to speed with what you need. They are responsible for their own training and you can ask if they are up to date with the latest regulations, knowledge etc. This can be great if you have a project or lack the expertise yourself e.g. think outsourcing marketing, HR, bookkeeping etc. 👍
✅ Flex & Goodbye – you can have a contract for services that is a fixed amount of time, to deliver a brief, a rolling weekly contract etc. But the benefit over an employee is that if you don’t like them – you can easily pull the plug (provided you have a contract for services in place that allows for this) and terminate the contract immediately if you’re not happy with their work. No reasons needed (but at the end of the day, they are human so it’s good to be decent about it).
✅ It's Cheaper – It’s generally cheaper (unless you use them a lot) they generally look after their taxes and National Insurance contributions and do not have the same rights as employees. You can pay whatever you like, as the national minimum wage does not apply. There’s no sick pay, benefits, pension etc.
✅ No equipment needed - They should have their own equipment / tools as a self-employed contractor – so you should not be providing them with a car / van / laptop / first aid kit / phone or whatever else they need. So, less hassle and cost. But obviously check they do have what's needed before you hire them!
✅ They should have their own insurance – But you should definitely make sure they do when you hire them and ask for details of which types and cover amount so it’s sufficient. As some newbies may not, if something goes wrong, the bill may come to you.
✅ No worries – unlike employees, contractors don’t have many employment rights for you to have to worry about. The two big ones they do have is you providing a safe working environment and also not being discriminated against.
SOUNDS GREAT – SO WHAT’S THE DOWNSIDE? 🤔
❌ You’re not their number one – I’m sorry to have to break it to you, but contractors typically work for lots of companies and I hate to say it, but you’re unlikely to be their number one priority. And if they don’t work for lots of companies, they probably shouldn’t be a contractor at all (more to come on this)
❌ Higher hourly rates – To cover the risks associated with not having full-time jobs, contractors usually charge more than an employee would in terms of the hourly rate. So, if you are going to be using them a lot, you could pay more than the savings on taxes, benefits, and payroll management services
❌ They're ultimately in control - You have less say and control over the work because they should independently determine how best to get the work done. So, this means as long as they deliver the brief, they can choose how, where and when the work gets done. Obviously some tasks have obvious requirements and are driven by customers, but a court would look at who has overall control in any dispute situation as one measure of the employment status.
❌ They can delegate to a subcontractor – If they get busy or popular, you may find your precious tasks being delegated to someone else, although you would still pay your contractor as normal. So, if you really like the person, you may not always have them do the work and if you're paying for.
❌ Lack of continuity - When a Contractor finishes an assignment, they might not be available the next time you need them. This has happened to me a lot! And it’s very frustrating
❌ You probably won’t be BFFs - Often contractors do the work remotely so face-time is limited and it’s a little harder to develop a relationship like you do when with employees you see every day. So if you're wanting a new best friend on another person to work closely with, an employee is a better option.
WHY IT MATTERS ?
This matters more if you decide to hire a Contractor.
Generally, Contractors are considered the easier and cheaper option, but it really does depend on your business model, so don't feel pressured to copy someone else.
But if you do decide to hire a Contractor, the employment status is a bigger deal for two reasons. Employment Rights and Tax Implications.
As I said earlier, Contractors get very few rights and Employees get A LOT. So, if there’s a problem with your Contractor, and they claim they are actually an Employee, you can be in hot water if there’s any truth behind it.
If they take you to a tribunal and they win, you may have to pay EVERYTHING they are owed, which could include holiday pay, sick pay, redundancy pay etc going back YEARS.
The second reason why it matters is due to TAX!
You pay a different amount of employer tax for your employees than you do for corporation tax with contractors. As you pay less for contractors, HMRC don’t like it when businesses hire contractors but they treat them like an employee, because they are losing out on tax (this is called a disguised employee).
So, as they do spot checks on companies from time to time, they may come after you and the Contractor for unpaid taxes if they feel that you have a disguised employee.
The IR35 is essentially the law to crack down this, and make sure you pay the correct tax - although the rules for the private sector have been delayed until April 2021 because of Coronavirus.
Download a copy of my FREE HR Nightmares Guide, which shares 5 of the most common mistakes small business owners make and how to avoid them.
How will you know if your Contractor has other clients, to check IR35?
You'll find loads of online tests you can ask your Contractor to complete. Here's an example.
Ultimately, it depends on:
Mutuality of Obligation - Is there loyalty or an obligation for the individual to accept the work that's offered (employees would have to do the work, whereas there should be no mutual obligation for contractors to accept or be offered work).
Control - Contractors should have much more freedom in terms of who, when and where the work is done, as long as they provide the services required
Substitution - Whether they always carry out the work or they have the freedom to delegate to a subcontractor (employees cannot provide a substitute. They always have to do the work themselves).
However, it isn't just how a person does the work that defines employment status. The court will also consider what the role/work is, and how long they've been working with you.
FINALLY, THERE'S ONE OTHER THING FOR YOU TO CONSIDER
Another option worth mentioning is Workers (another type of employment status along with employees and contractors) which are kind of in between an employee and a contractor.
Zero Hour Workers would be a good example of this. This is where the person is only paid for the hours they work. It's really good for when you have ad hoc requirements or a seasonal business, where demand fluctuates, and you need a flexible workforce, so a combination of employees and zero hour workers.
TO SUM THINGS UP THEN
✅ If you engage people to work for you, you should think carefully about their employment status (if you don’t, they or HMRC might). It’s in your interest and the person you are hiring – to get the employment status right
📚 Make sure you put a contract in place that determines what they are and the correct ways of working. The general rule is: If you are hiring an Employee, you need an Employment Contract. If you are hiring a Self-Employed Contractor, you need a Contract for Services. If you are a Contractor and you want to delegate or subcontract work to another person who also has their own business, you need a Subcontractor Agreement.
Here's a link to all the Contract Templates available in my shop, to save you bags of time and help you protect your business.
⚠ HMRC doesn’t like tax dodgers (even accidental ones) So make sure the paperwork and the reality tell the same story. Saying that someone is one thing when they are clearly another, as this won’t wash with the courts.
💬 Review the employment status regularly – sometimes contractors do become employees over time so keep checking it’s still right.
It is a bit confusing, so feel free to book a free consultation with me if you have questions, and I can explain a bit more.
Virtual HR Director & Leadership Mentor. I create game-changing HR & Hiring Strategies for ambitious small businesses in the UK and support you to lead your team with confidence. Check out my shop to download HR Templates & Contracts designed to make life easier.