Engaging a UK contractor can bring many benefits to foreign companies looking to operate in the country. Whether you have a new project that requires local support or you want to “test the water” of the local market, contractors can help and fill the gap. By using contractors, companies can avoid the hassle of setting up employee benefits schemes, payroll and a full work environment.
Throughout this article, we will use the word “contractor” to mean a “non-employee”. The same guidelines also apply in the United Kingdom to consultants, freelancers, agency workers and temps.
How easy is it to engage a UK Contractor?
Compared to other countries around the world, It is fairly easy to engage a contractor in the UK. All you need is a service contract between the engaging company and the contractor.
There are a few key points you should check to ensure no potential employer-employee relationship. We will review these points in this article. Further information on engaging UK contractors and more can be found on our Global Expansion Platform.
Ways to engage a UK contractor
There are 3 ways to engage a UK contractor:
1. Direct service contract with a contractor who is a sole trader
- Definition: A UK Sole Trader is a self-employed person who is the owner of a business and personally responsible for any losses.
- Considerations for the engaging company: Most businesses and even agencies don’t do business with sole traders. This is because sole traders can claim employment rights from the client. Moreover, under the Managed Services Legislation, a company could be liable for the unpaid tax liabilities of contractors who have ceased trading and owe money to the UK tax authorities.
- Considerations for the contractor: Becoming a sole trader is the easiest and fastest way to start trading and therefore many contractors prefer this is the first step.
2. Direct service contract with a contractor who is a Limited Liability Company
- Definition: The contractor incorporates a limited liability company and is essentially employed by his own company. There are nearly 550,000 limited companies in the UK who are run by sole directors and a large proportion of them are used to provide contracting services.
- Considerations for the engaging company: The engaging company signs a service agreement with the Limited Liability Company (LLC) and there is no employee-employer relationship.
- Considerations for the contractor: For long term contractors, an LLC is a recommended route. It offers a favorable tax structure (if not under IR35 – see details in tax section below) with nearly 25% less in taxes which usually out-ways the additional administrative tasks of running an LLC.
3. Direct service contract with an umbrella company
- Definition: an Umbrella company is an agency that provides payroll and administrative services for contractors. The contractors are employees of the umbrella company.
- Considerations for the engaging company: The engaging company signs a service agreement with the umbrella company and there is no employee-employer relationship. Make sure to carefully choose the umbrella company and pay attention to small print in the contract (such as terms for ending such an agreement).
- Considerations for the contractor: Using an Umbrella company is usually a great short term solution for contractors. The Umbrella company handles payroll, accounting, tax and administrative services for the contractor and the contractor does not need to set up and run an LLC. This set-up is less tax efficient for long term contractors.
How to choose between the three options? For the engaging company – signing a service agreement with an umbrella company or an incorporated contractor should be the same and will usually depend on if the contractor wants to incorporate.
Taxes and contributions
You are not required to contribute national insurance nor pension for the contractor.
The contractor might be required to issue a VAT receipt on their services to you. A chartered accountant will be able to advise the contractor if they are required to do so. As of May 2018, the standard VAT rate is 20%.
A tax legislation impacting the contractor and not the engaging company. Read on if your contractor has made specific requests as a result of this legislation.
What is it: A tax legislation that applies to workers who provide services to clients through their own intermediary, such as a limited liability company, but would be considered an employee if they were providing their services directly.
If caught by IR35, the contractor will have to pay income tax and National Insurance Contributions (NICs) as if they were employed. This can reduce the worker’s net income by up to 25%.
How much should I pay the UK contractor?
Just like full time employees, contractor rates in the UK vary by sector, type of work and experience.
There are two ways to figure out the range of rates for a contractor:
- If you are working with an umbrella company or a recruitment agency, they will be able to advise you on the going rate.
- Calculate the rate yourself based on the base salary of a full time employee (see image below).
*Contracts who qualify for IR35 exemption could eliminate up to 25% of tax and national insurance costs.
Terminating the contract with a UK contractor
Contractors are protected by commercial law. If you terminate the contract ahead of the time and with no notice period, you will be in breach of contract. In this case the contractor is entitled to pursue remedies.
If the nature of your engagement with the contractor does not have a fixed time period, be sure to detail a short notice period in the contract. This will provide you with the needed level of flexibility.
When done correctly, engaging a contractor can be a quick way for foreign companies to start operating in the United Kingdom.
Among other things, companies should take into account:
- The legal entity they engage with
- The expected fully loaded cost
- The potential tax implications on the contractor
- The expected length of the project
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This article provides general information and should not be taken as legal or HR advice. We recommend consulting with a lawyer for specific advice to your business.