What pay less tax than their employed equivalents
What is the definition of a contractor?
In the UK, the meaning of a contractor is a person that
provides skills or services without being directly employed by any one client.
By definition, contractor jobs are not permanent; they last for designated
blocks of time, which can vary from one day to several months.
Working as a contractor means you can offer your skills on a
business-to-business basis and move very quickly, securing jobs within days
rather than having to go through the lengthy recruitment process experienced by
a permanent employee. A self employed contractor is paid a designated day or
hourly rate and would expect their contract to come to an end on a mutually
agreed date, which is confirmed in a formal written agreement. Limited company
contractors often use specialised agencies to secure jobs, something which is
not an option for sole traders due to Section 134 of the Income & Corporation Taxes Act 1988.
Often, an independent contractor will work under a self
employed contract. The main advantage of working in this way is that self
employed contractors tend to pay less tax than their employed equivalents and
can take home a greater percentage of their gross fee. A self employed
contractor is not paid through PAYE and is responsible for their own contractor
tax and expenses. Employment rights for self employed workers are not nearly as
comprehensive as they are for traditional employees, with only limited
protections afforded. However, contractors can be classed as employees if they
engage the services of an umbrella company, who handle their tax
responsibilities much like a traditional employer.
In understanding the definition of a contractor, it’s
equally important to know what they don’t do – there are several very similar
employment terms that appear to cover the same ground but mean something
The difference between a freelance worker and a contractor
is that while both types of workers have to deal with the HMRC directly, a
contractor typically works on site for one client at a time. The classic
example of this would be an IT contractor. IT contractor jobs are usually
centred around a particular project or to fill a gap in the company’s skill
set. In contrast, a freelancer usually works from home, can take on several
clients at once, often without a formal contract and typically specialise in
jobs in the creative industries such as copywriting or editing.
The key difference between a contractor and a consultant is
that though both are highly skilled knowledge workers, contractors are usually
brought in by clients to address a specific project or skills gap. Contractor
pay is drawn at either a daily or hourly rate and then once the project is
over, they will move on. A consultant’s work structure is different: they’re
usually paid on a monthly retainer or a high day rate and while they will
probably not work on site or every day, they are on-call anytime the client
How do I set up as a contractor?
If you’re looking to set up a company, the first thing you
have to do is legally define the type of business you intend to run. This is
not about what industry you’re in, instead it’s about thinking how you intend
to source your clients, the structure of your working life and how involved you
want to be in the tax and administrative side of your contracting business. In
the first instance, you have two options: registering as a sole trader or
setting up a limited company.
Self employed or limited company?
Sole traders are rare in the contracting business as various
taxation laws make it difficult for them to work with agencies. Agencies
require you to be a limited company because otherwise they are liable for any
lost taxation you might incur. In addition, clients are often reluctant to
engage a sole trader as it leaves them vulnerable to considerable cost if, in
the event of an Employment Tribunal, contractors attempt to claim employees
Setting up a company as a self employed sole trader is easy
and this is its key advantage. It’s also not a binding decision – you can
register as a limited company at a later date, should you wish to do so. To
become a sole trader, all you have to do is register with the HMRC, something
that can be done immediately. You can contact HMRC and declare your intentions
by visiting their online portal or by calling the HMRC Newly Self Employed
Helpline on 0300
However, for the reasons listed
above and because becoming a sole trader makes you personally liable should
your business run at a loss, we strongly recommend that you set up a limited
company – you can read our guide to starting one here.
Once you’ve set up a company and
you’ve sorted your legally required business bank account and insurance, you
can begin to seek out clients. You might do this through agencies, contractor
job forums or approaching prospective clients directly. Make sure you have a
sharply written CV tailored to each client’s expectations and be prepared to do
a lot of networking!
How much should a contractor
It’s the question every first timer asks: how do I work out
an hourly rate for my services that properly reflects my worth? It’s not as
simple as converting a salary to a contract rate because unlike a traditional
employee, you’ll be responsible for a whole host of costs and taxes specific to
running your own business. A contractor
salary has to include all your expenses and benefits. It is important therefore
that you work out a rate that is sustainable and allows you to remain
competitive in your marketplace.
Working out your hourly rate involves a series of calculations
that ensure you quote neither too high nor too low. The first thing to do is to
calculate how much of your income will disappear in the form of insurance
payments, pension plans, travel, umbrella company costs and taxation. Obviously,
your contract rate cannot go below this base figure and you should be ambitious
about setting your final daily rate. Here are some things to consider:
Your skill set – do you have any niche skills that make
your presence more valuable?
Your location – contracting in London and the South
East will fetch the most competitive rates.
Your experience – the longer you have been working in
your chosen field, the more income you can potentially claim.
Your industry – IT contractor rates will probably look
a lot different to farm contractor rates – it sounds obvious but there’s a lot
of misinformation online and it’s important to make sure your research is
You will find talking to your colleagues helpful when you’re
working out your own contractor rates. Find out what people with similar skills
charge and then take this information to several different agencies. Learning
to negotiate early on is a big step in how to maximise your income effectively.
Sound agencies out as regards their going rate – remember that their goal is to
make their margin as large as possible. It’s your job to make sure that their
offer to you is just as lucrative – working as a contractor means that you
cannot afford to underestimate your worth. Add a fixed amount to their quoted
figure and see if they accept it.
Regardless of their response, take the same offer to a several other
agencies and gauge the average reaction. This will give you an idea of the
general parameters of your industry and ensure that your quote is both fair and
reflective of your talents.
What do you need to become a
The leap from permanent to contract work can be daunting but
if you’re properly prepared, it can be a relatively easy process. There are
four main areas that you need to consider if you’re contemplating how to become
a contractor: clearing your work schedule, finding work, establishing your
payment structure and making a contingency plan.
Clearing your work schedule
The nature of contract jobs in the UK mean that
opportunities can arise very quickly and you can find yourself signing a
contract within days of hearing about a job. If you are still in regular
permanent employment, you’ll find it incredibly difficult to pivot at the speed
you need to get the best jobs. There are exceptions, but it is usually
essential for a contractor to have left their permanent job before they start a
To find work quickly, you need to establish a network of
contacts and have a high impact CV that establishes your value in the
contractor marketplace. You can contact employment agencies that deal with
contractors, use online job boards and utilise your existing networks. You also
need to think about where you will concentrate your efforts – for a UK
contractor, contracting in London offers the greatest variety of jobs and is
the most lucrative option, but you can make a decent living working elsewhere
as long as you research the job market.
Establishing a payment structure
Becoming a contractor means deciding what kind of business
you want to run. Most contractors choose to set up limited companies which
means that you need to hire an accountant, set up a business bank account and
establish the manner in which you wish to be paid. Whether you choose to work
with an umbrella company or run a limited company, you will need to establish
your IR35 tax status so that you pay the correct amount to HMRC.
Making a contingency plan
As every UK contractor knows, when you run your own
contracting business, you are solely responsible for every aspect of your
personal and professional life, including providing yourself with holiday pay,
sick pay and a pension. Before you start working as a self employed contractor,
you need to know how you’re going to take care of yourself when you’re not
working. Work out your bare minimum rate by taking account of both your regular
monthly expenses and what you have to put aside for leaner times.
How to get
paid as a contractor
The way you get paid as a contractor will depend on what
type of business you have set up for yourself. You will have either joined an
umbrella company which will invoice the client and pay you themselves, dealing
with all the tax deductions for contract workers, or you will be a sole
trader/limited company and you’ll have to invoice your client for your
contracting work yourself. Your invoice will be based upon the payment terms
you have agreed with your client.
What is meant by payment terms?
Payment terms refer to the time period you’ll allow for the
client to pay the money they owe you. The law assumes 30 days payment terms,
but you can specify a shorter turnaround than that: anything from 7 to 14 days
are standard payment terms for contractors. Some clients even agree to paying
contractors up front – it just depends what you can negotiate. The payment
cycle process can be long, especially if you’re dealing with a larger company
who have complex payroll practices, so it’s in the interest of both you and
your client to raise invoices as soon as they become due. It is standard practice
that you agree payment terms in advance.
Making an invoice is not too difficult – you can even search
and download invoice templates online. There are several important elements
that your invoice needs to contain.
Your company’s name and registered number (you can find
this on your certificate of incorporation)
If you are VAT registered, a unique identifying number
(this can be anything you like but must be sequential with all other invoices
that you raise)
Your contact details and those of the person/company
The date the invoice was issued
A ‘tax point’ (the date you actually supplied the
services you’re invoicing for)
The full amount you’re asking for, with hours and rates
clearly defined and a short description of the work e.g. ‘IT contracting
Any reference number (also known as a PO Number) given
to you by the client
A list of expenses (including VAT) if any have been
How you’d like to receive your money and the
appropriate banking details
Your agreed payment terms
The list above is particularly applicable to contractors who
get paid after the work is completed but you may have negotiated different
payment terms with your client. If you’re on a job that is likely to last a
lengthy period, you can invoice for your time once a month, even if the job is
not yet completed. Recruitment agency payment terms mean you will get paid
regularly, either weekly or monthly – make sure to check how your agency
handles things before you start your assignment so that you can plan your