HR Consulting FAQ: The Difference Between an Employee and Contractor
HR Consulting FAQ: The Difference Between an Employee and Contractor

HR Consulting FAQ: The Difference Between an Employee and Contractor

If you have a million questions about employees and contractors, we have the answers

Not everyone who works for you will necessarily be considered an employee. Some individuals may fall under the category of contractor, but what is the real difference between an employee and a contractor? Why does it matter and which alternative is best for your business? As an HR outsourcing service, we frequently get asked these questions. While it is legally important to distinguish between the two, the answer to which is more appropriate for you is largely dependent on the needs and motivations of your organisation.

This article will take you through the following:

  • Three common law principles to determine whether an individual is an employee or a contractor
  • Benefits of hiring employees
  • Considerations prior to hiring employees
  • Benefits of hiring contractors
  • Considerations prior to hiring contractors
  • Examples of differences between contractors and employees
  • Legal implications of failing to distinguish the relationship

Three common law principles to determine whether an individual is an employee or a contractor

There are three common law principles that can be applied to any given individual in order to differentiate employees from contractors. These principles are known as Personal Service, Control and Mutuality of Obligation.

Personal Service

Consider who actually carries out the assigned work. Must the individual themselves complete any given tasks themselves, or can they send an appropriate replacement of their choice?

If the business requires the individual to provide the service personally (i.e. if the individual is unwell or is on holiday, they are not permitted to send a suitable replacement in their place), they are likely to be an employee.

If it does not matter who provides the service, so long as the work is completed and the individual can send a suitable replacement in their place, they are likely to be a contractor.

Control

Who controls how, where and when the individual works? Is this determined by the business or the individual?

If your company has specific, detailed instructions and a high degree of control over the individual, this is indicative of a contracted employee. These same individuals will be told where they must work from and when they need to perform the given service (e.g. Monday to Friday, 9am to 5.30pm).

Fewer instructions and greater autonomy indicates the individual is more likely to be an independent contractor. Contractors decide where they work from, what time they work and how the work is completed.

Mutuality of Obligation

Is there an obligation to the other party? Is the business obliged to provide work and is the individual obliged to accept the work?

If the business is obliged to provide the work and the individual obliged to accept and carry out the work, the individual is likely to be an employee. If the business is not obliged to provide the work and the individual does not have to accept, it is likely the individual is a contractor.

However, you must be careful not to confuse a worker on a zero hours contract for a contractor. A zero hours contract allows the business to call upon staff as and when they need additional cover, without either party being obliged to offer or accept the work and with no penalties for either party if work is not offered or accepted. In this instance, where the business offers work and the individual accepts, the individual would be required to carry out the work personally and would accrue employment rights, such as holidays. Such individuals are likely to fall under the category of employee.

Benefits of hiring employees

  • Commitment: Employees have more loyalty towards their role and company than a contractor, which can result in more productivity from your employees. Hiring employees can also provide a constant and stable workforce
  • Control: An employer can determine the days, hours and location they want their employees to work from
  • Leave: An employer can decide when an employee takes annual leave
  • Managerial Responsibilities: Loyal employees who have been with the business for a number of years should have the best understanding of the business, meaning they can help to train new staff members
  • Rates: An employer can determine the rate of pay/salary for each employee
  • Security: An employer can restrict who else their employees work for, so you can be sure that your employee is committed to your business
  • Skill set: Employees can be asked and trained to take on additional roles and responsibilities as and when the company requires. This allows for a company to develop a flexible workforce with a variable skill set
  • Workflow: Asking one employee to manage multiple projects can be easier to manage than numerous contractors

Considerations prior to hiring employees

  • Changing work demands: Where work diminishes or there are certain restructures which render dismissing staff necessary, an employer is legally obliged to pay employees redundancy pay (provided the employee has the relevant length of service)
  • Employment rights: Employees have employment rights based on length of service, some of which commence from day one of employment
  • Labour costs: Employees need to be paid during quieter periods, as well as when work is not available
  • Liability: An employer will need to have employer’s liability insurance to cover employees
  • Overheads: An employer must provide all employees with the tools and equipment with which they are required to work. The employer will be required to pay employer’s tax and National Insurance for employees and make the appropriate deductions from the payroll to pay the employee’s tax and NI via the HM Revenue and Customs (HMRC) Pay As You Earn system (PAYE)
  • Transitioning role: Growing companies need employees who are able to manage other people, as well as their workload. A business may need to train its staff to become people managers
  • Performance management: If you notice an employee slipping, rather than cutting your losses and recruiting someone new, you are obligated to manage employee underperformance, which often takes significant time and effort

Benefits of hiring contractors

  • Changing work demands: As a result of the changing status of the UK economy, more and more employers are gaining flexibility by hiring contractors. When work demands change, an employer can increase or decrease the number of contractors they use
  • Liability: Independent contractors need to maintain their own public liability insurance
  • Overheads: An independent contractor is responsible for paying their own tax and NI, as well as providing their own equipment to work from. Independent contractors are not entitled to company benefits
  • Skill set: Independent contractors are normally experienced individuals with a specialist skill set. They may also have experience working in different industries/companies

Considerations prior to hiring contractors

  • Commitment: Contractors may be working on other projects for other companies at the same time as working for you
  • Control: An independent contractor has more control to determine when and where they work from
  • Rates: Contractors can vary their hourly/daily rate by project and overall market demand. VAT is payable on invoices
  • Security: There is a risk that an independent contractor may also work for a competitor (the employer would need to ensure that the agreement included a confidentiality clause and an appropriate restrictions clause)
  • Workflow: An independent contractor can decide not to take on additional work from you and can re-negotiate their rate of pay if they agree to take on any additional work

Examples of differences between contractors and employees

Some examples of the differences between employees and contractors include:

Liability Insurance: Contractors usually have their own liability insurance, whereas employees should be covered by the company’s liability insurance.

Payment: Payment for a contractor is usually made by the contractor providing an invoice for the work they have completed. Employees are paid automatically on a weekly/monthly basis, without having to provide invoices for their time or work completed. An employee’s weekly/monthly salary should be based on their annual salary or hourly rate of pay agreed at the start of the employment relationship.

Differences in employment rights are detailed in the table below:

Employment Rights Employees Contractors
Entitlement to receive a written statement of employment particulars within two months of start date
Entitlement to receive at least the national minimum wage (NMW)
Entitlement to receive at least 5.6 weeks paid annual leave (or the equivalent for part-time employees)
Entitlement to receive statutory sick pay (SSP)
Entitlement to join the company’s pension scheme
Entitlement to protection against less favourable treatment for being a part-time employee
Entitlement to protection against less favourable treatment for whistleblowing
Entitlement to protection from unauthorised salary deductions
Entitlement to statutory redundancy payments
Company disciplinary & grievance procedures apply
Right to request flexible working

Eligibility criteria applies

Right to unpaid maternity leave

Eligibility criteria applies

Right to request flexible working

Eligibility criteria applies

Right to unpaid paternity leave

Eligibility criteria applies

Health & Safety
Data protection

 

Legal implications of failing to distinguish the relationship

It is important to define the status of an employment relationship, as employees are entitled to certain benefits and employment rights that contractors are not (some of which have been detailed above). Failure to classify the type of relationship correctly has a number of legal and financial consequences.

For example, employees are protected by the Employment Rights Act 1996 and are entitled to receive a statutory redundancy payment, maternity, paternity and adoption leave and pay, and the right not to be unfairly dismissed.

A contractor who can successfully claim that they are an employee can make a claim against the company they work for at an employment tribunal for unfair dismissal, provided they have the relevant length of service (two years continuous service if employed after 1 April 2012).

To ensure that you are complying with your legal obligations as an employer, at the commencement of any employment relationship it is recommended (and legally required for employees by the Employment Rights Act 1996) to provide the appropriate written agreement for the individual. For employees, this will be a ‘contract of services’. For a contractor, this will be a ‘contract for services’.

An employment Tribunal will determine the employment relationship by considering all of the above-mentioned factors together and not separately. Having a written agreement is not enough by itself; you must ensure that the employment relationship with the individual is as described by the agreement.

Need Help? Still in a dilemma about the difference between an employee or contractor? Or not sure you have the correct HR documentation in place? PlusHR’s qualified HR team are on hand to ensure you are on the right path. If you would like more information or advice please get in touch by email or phone.

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