With a long history of passing legislation friendly to businesses, a vast and developed potential market, and a highly educated workforce, it is obvious why companies turn to hiring in the UK. One option for recruitment in the UK is to work with independent contractors. But then the question arises, how can I pay independent contractors in the UK safely and efficiently?
What are the Differences Between Employees and Independent Contractors in the UK? Know Your Responsibilities
Contractors in the UK are classed as self-employed. This means that they will work with one or several clients, typically through a sole trading company or small limited company. As such, they have neither the rights of an employee nor the same obligations to their client company.
Employees in the UK are paid through the PAYE (Pay As You Earn) system. This is where deductions for tax and National Insurance (NI) are made at source by the employer.
This also includes the obligation for employers to contribute the equivalent of around 17.3% of an employee’s salary towards the employee’s social security. These contributions pay for all the typical benefit plans that employees enjoy in the UK. This includes pension, healthcare, and various forms of leave.
For contractors, these additional costs do not exist. However, companies should not see this as a way to pay independent contractors less and save money.
Independent Contractor Agreements
Employees are bound to a single employer by an employment contract. On the other hand, contractors typically work with multiple clients. They also agree only to the specific requirements as detailed in a contractor work agreement.
Companies must fulfill mandatory legal obligations to employees that protect the worker’s rights and safety. In return, employees agree to perform their tasks in the manner of the company’s choosing. This includes completing tasks when and where desired. They will also use the tools and location provided by the company.
With contractors, companies are not obligated to provide anything beyond payment. Here, the worker uses their own tools and resources to complete a task in a manner of their own choosing. As such, company responsibilities towards contractors are minimal and contractors determine their work life balance.
Employment Laws in the UK and How They Relate to Contractors
In general, contractors are not bound by the usual employment laws, and employer responsibilities do not apply to them. In a contractor agreement, the client company is not required to provide any employment protections or rights.
When someone becomes self-employed in the UK, they enjoy similar benefits and protections to an employee. However, they gain these benefits directly as a result of their own tax payments.
The UK government provides an online tool that allows you to check if someone is self-employed or not. Treating an employee as a contractor or vice versa in the UK is called misclassification, and it comes with a set of potentially devastating consequences. We will outline these risks below.
How the UK Handles Taxes and Other Payroll Costs for Independent Contractors
Contractors in the UK manage their own tax payments through a government self-assessment service and tax form. Typically, a contractor sets themselves up as a sole trader and pays income tax on all earnings beyond £12,570 per year.
This is done yearly, with National Insurance contributions also being made at the same time. Sole traders turning over more than £85,000 must also pay VAT.
They may also have an arrangement with an Umbrella Company that will take charge of taxes and other costs for them.
All of this allows contractors to enjoy retirement benefits and social insurance benefits. However, they don’t receive the same level of security as employees.
What are the Risks of Misclassification in the UK?
According to UK law, treating a contractor like an employee while still paying them as a contractor is classified as depriving them of their rights and protections as an employee.
For some companies, the ability to pay independent contractors without NI contributions is seen as a way to save money on costs related to employer obligations. However, without knowing about how to manage employees and contractors, companies run serious risks.
In the UK, a company caught misclassifying a worker as a contractor (when in reality they perform the work of an employee) faces the following costly penalties:
- The worker becomes automatically converted into an employee. They also receive payment for all the employee benefits they should have enjoyed since the beginning of the working relationship (including things like annual leave, and minimum wage)
- The company must pay the total amount of NI contributions that should have been paid, plus interest
- The company may be investigated for fraud and face additional criminal charges due to the act of misclassification depriving the employee of their rights and the government of tax and social insurance funds
How Do I Convert an Independent Contractor into an Employee in the UK?
When a contractor performs their work particularly well, or they possess specific skills that a company might wish to retain permanently, you may want to convert that contractor into a full employee. It might also be too expensive to pay independent contractors long-term due to a high hourly rate.
In order to do this safely and accurately, it’s best to follow these steps:
Convince the contractor of the benefits of becoming an employee
The transition from contractor to employee brings many advantages for the worker, such as retirement plans, life insurance, a regular salary, integration into a company’s culture and team, and added security. You may also have to guarantee some benefits they enjoyed as a contractor like the option to work from home or other fringe benefits.
Your job here is to lay these benefits clearly out when discussing your intentions with the contractor.
Check that the contractor would be a viable employee according to UK law
By using the online tool mentioned above, a company can check the contractor’s employment status. This way you can ensure the contractor is able to be transitioned into an employee.
The contractor will also have to be made aware that the new situation may mean changes to the way they work with other clients. This means that they may be obliged to end other business relationships.
Understand the way the relationship changes and clearly lay out these changes in an employment contract
One big change to consider will be the new employee’s salary. It’s important to keep in mind that they have to be paid according to the national minimum wage and also be eligible for all paid leave types. Additionally, indirect costs such as social insurance contributions must now be factored into the employee’s true labor rate.
The contractor will also now be obliged to perform tasks as requested. This requires a loss of potential freedom in the way they work.
All of these changes must be clearly outlined in an employment contract which should be made in writing to avoid potential disputes.
Add the new employee to your payroll system
Once a salary is negotiated, the employee will need to be added to the PAYE system. You will have to manage tax and social insurance deductions from the employee’s gross salary each month.
Here, you are required to have a company structure in the UK capable of managing payroll according to the PAYE system. You’ll also have to have the HR staff in place to manage it.
Any errors at this stage will quickly damage the worker’s confidence in your ability to offer them the protections they need as an employee. Because of this, it’s important to take the time to manage this correctly. You can even seek the guidance of a professional payroll service to reduce the risk of complications.
Follow your typical onboarding process (with some changes)
Contractors who become employees will already be familiar with your company. Because of this, they may require fewer onboarding procedures like interviews. As specialists in their field, they will also probably require less training.
However, properly integrating the new employee and showing them the benefits of the new arrangement may mean that you need to take extra steps during this process to show them they are now a valued member of the team.
If your organization in the UK does not have the structure available to follow these steps carefully, an Employer of Record (EOR) can provide the necessary structure, HR support, and payroll management for you.
Four Helpful Ways to Pay Independent Contractors in the UK
Direct deposits can be used to pay contracts once or often, depending on your work agreement and payment schedule.
Be cautious to keep contractor payments distinct from other payments made to regular workers. Additionally, keep in mind not to make the same deductions as you would with workers.
Checks used to be the favored payment method for the majority of contractors, but they are now much less popular. Checks are less trusted due to their relative rarity and the possibility of bouncing. They are slower than electronic payments, have the potential to be lost or destroyed, and take longer to process.
PayPal or Other Online Payment Systems
PayPal has lost a lot of popularity over the years due to an expanding number of online payment system competitors. Many people find an online payment to be a decent alternative because of its security, use, and speed.
The drawbacks of these systems include the potential requirement for the contractor to have a business account. There may also be relatively high fees for transactions. This last issue is particularly true when paying overseas contractors.
Guaranteed Payroll Services
Payroll partners and services from third parties are created expressly to pay independent contractors and other self-employed workers on time and in compliance with the law. These might take the shape of an umbrella business that administers the payroll for them. It may also be through a PEO that can manage payroll legally through HR outsourcing services.
These payroll partners have the legal knowledge to ensure that your payment is processed correctly and following all applicable laws.