Contractor, Consultant, Employee – What’s the difference?

When taking on a new member of staff, there are generally two options available for appointing a new worker. You could either take this person on as an employee, or you could appoint them as a contractor. NB, sometimes a contractor may be referred to as a ‘consultant’ but, essentially, these two terms are really the same thing.

Where it’s possible to do so, it’s often in the company’s best interest to appoint new staff members as contractors, rather than employees. Conversely, it’s usually preferable for the worker themselves to be taken on as an employee, rather than a contractor.

The main factors involved in deciding whether to make someone an employee or a contractor revolve around the following issues.

Avoiding restrictive legislation A contractor doesn’t receive rights to redundancy payments, and also can’t claim unfair dismissal. They also lose out on pension rights and maternity or paternity leave. So employing contractors instead of employees can, potentially, save an employer a lot of money and legal complications.

Reducing tax If a worker is taken on as an employee, it means that the employer will be required to pay their salary ‘gross’. This means the employer is paying the employee’s income tax (through the PAYE system) and paying across the net amount to the employee. The employer will also have to pay National Insurance Contributions, which they wouldn’t have to do if the worker was a contractor.

From the worker’s perspective, if they are hired as a contractor instead of an employee, they will receive their wages without any deductions, so they may end up receiving a higher wage as a result. It will be up to the contractor to pay his own tax, but he may be able to reduce the amount he pays by setting off relevant expenses, for example.

These factors really only apply where it’s possible for the parties to choose which type of contract they want to enter into. However, by law, a person will actually be defined as an ‘employee’ or as a ‘contractor’ depending on the underlying nature of the relationship between the parties, and not simply based on the type of contract that the parties sign.

This means that if the parties sign a contractor or consultancy agreement when the worker is really a ‘disguised employee’, then the worker will be treated as a true employee by law, and the parties can be subject to tax and penalties if there is any underpayment of tax. The legal differences between an employee and a contractor are outside the scope of this post, so it’s important to check with your lawyer whether it’s legally possible to rely on claims that a particular worker is a contractor and not an employee.

There used to be an apparently simple method of bypassing the employee rules by appointing a ‘service company’ as the named contractor, rather than making the contract with a specific individual. However, this ‘loophole’ was dealt a blow by the IR35 legislation, which allows the law to see right through a contract, even if it is made with a service company instead of directly with an individual.

Therefore, the general rules of what makes a worker an employee as opposed to a contractor will still apply, and it won’t be enough simply to rely on the wording of your contract. That said, in those grey areas, where both types of contract may be applicable, it will be important to draft your contract carefully to ensure you fall on the right side of the line.