While both employees and contractors offer their services in exchange for payment, they represent two distinct categories within the workforce. So, what exactly differentiates them from one another? Employees generally work under set terms, which come with benefits and protections. Contractors, on the other hand, have more flexibility but fewer entitlements. It’s important to understand the key differences so you can make informed decisions when hiring or offering services.
This article covers:
The difference between employees and contractors
The legal, financial, and operational consequences that can arise from misclassification.
How to determine which classification best fits your business needs.
The benefits and challenges of employing workers versus hiring contractors.
Who Is Called An Employee?
An employee is someone who is hired to provide a specific service in exchange for compensation, which can be in the form of salary, wages, and other incentives. Before a person can be considered an employee, such an individual must have entered into a contractual agreement with the employer.
This contract is legally binding, and it contains vital details about the employment terms, including but not limited to:
Job responsibilities or description.
The employee's working hours, leave period, and sick leave.
Job benefits such as health insurance, wellness programs, paid time off, etc.
Conditions that could warrant employment termination and many more.
Employees are always bound by company policies. That is, throughout their employment period, they must not:
Violate company rules, procedures, or codes of conduct. This includes adhering to work schedules, following established workflows, and maintaining professional behaviour as outlined by the employer.
Leak sensitive information about the company to the press or a rival company unless they are instructed to do so.
Sexually harass their co-workers.
Disrupt the workplace environment.
Disregard workplace safety protocols.
Engage in any form of insubordination or refusal to follow management's instructions.
If an employee violates these policies, the punishment could range from employment termination, suspensions, warnings, or, in the worst-case scenario, legal action. Again, it all depends on the severity of the breach.
Who is called a contractor?
A contractor is an entity hired by a business owner to provide specific services for a fixed period of time. They are often referred to as freelancers or independent contractors. Although they also get compensated for service rendered, their employment status is not fixed and bound by any long-running contract. Also, unlike employees, contractors are responsible for their tools and equipment.
Advantages of Being a Contractor
A contractor is not bound by any company policies or codes of conduct.
In a literal sense, a contractor is independent. They can even work for more than one company simultaneously.
They won’t be under client supervision, so they’re free to decide when and how to complete their assignments as long as they meet the agreed-upon deadline.
They will get paid per project or based on an agreed fee.
Disadvantages of Being a Contractor
Since contractors do not receive a fixed salary or wage, and their income can be unpredictable, the likelihood of them going broke or bankrupt is very high.
They are not covered by the company's healthcare plans, which means that they will have to fund their healthcare.
They are also not eligible to receive a pension, which means that they will have to fund their retirement.
Key Differences Between Employees and Contractors
Control and Independence
One of the most significant differences between employees and contractors is the level of control exerted by the employer. Employers have a higher degree of control over employees than contractors. For example, employers can dictate their employees' work schedules, methods, and sometimes even the tools they use.
Payment and Benefits
As specified in their employment contract, employees are entitled to receive a fixed salary, hourly wage, or other forms of compensation for service rendered. Additionally, they are entitled to workplace benefits, including but not limited to pensions, health insurance, sick leave, maternity leave (for women), and many more. On the other hand, contractors bear their business costs and are responsible for securing their health insurance, pension, and other benefits.
Taxation and Legal Obligations
Employees and contractors are taxed differently. Employees, for example, are taxed through the PAYE (Pay As You Earn) system, where the employer deducts income tax before paying the employee. In contrast, contractors are responsible for their tax payments and filing tax returns through the self-assessment system. They may also be responsible for VAT (Value Added Tax) if they are VAT registered.
Employers must comply with specific regulations that define whether a worker is an employee or a contractor. The legal implications of worker misclassification can include significant penalties, back taxes, and disputes over worker rights.
Additionally, as an employer, at the end of your company’s financial year or when an employee leaves the workplace, you are legally obligated to provide them with necessary tax documentation, such as the P60s, P45s, and P11D forms. The P60 form, for example, will show a detailed breakdown of the income tax deducted from their salary throughout their employment year.
Duration and Stability
Contractors are hired to provide specific services for an agreed-upon period. Once they complete the task, their contract with the client ends. This differs from employees, whose employment is often full-time and continues until their employment contract is terminated or they part ways with the company by mutual agreement.
Legal Implications of Misclassification
Employers face serious consequences if they misclassify an employee as a contractor. Here are some potential risks:
Legal disputes: If you, an employer in the UK, misclassify an employee as a contractor, the HMRC could sue you and order you to pay a fine or back taxes.
Financial risks: Additionally, if you misclassify an employee, the affected individual may also claim entitlement to benefits such as holiday pay, minimum wage, and unfair dismissal protections. If this happens, your finances will suffer greatly.
Contractor vs. Employee Rights
Employees and contractors do not have the same rights and privileges. The following are the key areas where they differ:
Unlike independent contractors, employees have the legal right to sue their employer if they feel they have been unfairly dismissed. If they win, they could be compensated or reinstated to their roles.
Employees are also eligible for redundancy pay and paid leave.
Because they are not bound by any contractual agreement, unlike employees, contractors have the right to work with multiple clients simultaneously and set their own terms.
When to Hire an Employee vs. a Contractor
Deciding whether to hire an employee or a contractor depends on several factors, including:
Your business needs: Hiring an employee is often the best option for roles that require ongoing work, close supervision, or long-term commitment. On the other hand, contractors are ideal for short-term projects where flexibility is paramount.
Cost implication of hiring a contractor: Although contractors are not entitled to any benefits from the company, the overall cost of hiring a contractor can still be higher due to project-based rates and additional fees for specialised skills.
Flexibility and Scalability: If you own a business that doesn't require a full-time worker, you can hire contractors to come and work for a fixed time. For example, if you own a company and want to develop a personalised app, you don’t necessarily need to hire a full-time app developer for this role. Instead, you can hire a contractor to design and build the app on a project basis.
FAQs
How do I determine if someone is an employee or a contractor?
To decide if someone is an employee or a contractor, consider the level of control you have over their work, how they are paid, and if they receive benefits. They are likely an employee if you control their tasks, hours, and how they work. Contractors, on the other hand, usually have more independence and are paid per project or job.
What are the tax implications of hiring a contractor?
Unlike an employee, when you hire a contractor, you are exempt from deducting income tax from their compensation. This is because contractors are responsible for their taxes, which they pay through self-assessment.
Can a contractor become an employee?
Yes, a contractor can transition to employee status if the employer decides to offer a more permanent role. In such cases, the worker would gain employee benefits and legal protections.
What happens if I misclassify an employee as a contractor?
Misclassifying a worker can result in significant financial penalties, back taxes, and potential legal disputes. To be safer, try to seek clarification from an employment attorney to avoid misclassification.
Are contractors entitled to the same rights as employees?
No, contractors do not have the same statutory rights as employees, such as protection from unfair dismissal, entitlement to a paid leave, the company's health care plan, and many more.
Conclusion
Understanding the differences between employees and contractors is essential for employers to make informed hiring decisions. As a business owner or HR professional in the UK, if you need expert help on how to avoid misclassification, Lawhive is here to assist. Our team of employment solicitors can provide the guidance and support you need to ensure compliance and make the best choices for your business.