Contractors and freelancers, the terms are often mistakenly used interchangeably and may sound similar to the general public, but the mechanism through which both of these offer their services is quite different. The legislation does not specifically differentiate between them in terms of taxation, but the need of understanding the differences between the two is critically important when it comes to recognizing the tax liabilities and the business rights both of these are subjected to.

Individuals who seek self-employment usually offer their services either through either contracting or freelancing. The decision to work either as a contractor or a freelancer depends upon the industry they are associated with and the time period or deadlines they willingly accept during which they will offer their services. 

What do you need to know about a contractor?

Almost everyone is familiar with the term ‘contractor’ but not everyone understands the nature of their work. A contractor is someone who offers services to clients for a predetermined period of time and gets paid for the limited-service they offer. A contractor can either be an individual or an organization, ready to provide services to other individuals or organizations for a limited period of time. A contractual agreement is signed between the contractor and the client, that states the nature of the work, the time period of services that have to be provided and the income that is going to be earned by the contractor.

Client companies may allow such contractors to work within their firm or premises for a limited period of time, thus giving them a status of  ‘short-term employees’. As these short term employees are not set up on the company’s payroll, they are solely responsible for handling their taxes and NI on their own, unlike the permanent employees of the firm.

Recruitment and contracting agencies usually have a strong network of clients, that are searching for contractors, at their end. Contractors are able to connect with the clients through these agencies and if they work through these agencies they may fall under the ‘agency workers’ category according to the legislation, once they agree with the contract. Agency workers are able to secure some employment rights such as the National Minimum Wage. 

In some cases, these contractors can be considered as employees and can be conferred with supplemental rights and responsibilities, but that too if they sign up for ‘pay between assignments contract’ with the recruitment agency.

Contractors can work with a number of agencies to find them multiple suitable contract roles i.e. if the terms and conditions of the contractual agreement with the contract client permit them to, this is also further possible when the contractor is working as a self-employed contractor. However, they may be able to enjoy flexibility in their work during the period of the contract but won’t be able to enjoy any employment rights.

Companies when working on short term projects need short term services for these projects, as the nature of the project does not require for them to hire permanent employees, thus they seek contractors. For instance, this can be observed in the IT sector, where firms seek services from contractors for a limited period of time to manage and complete a particular project. Hiring contractors proves to be more efficient and fruitful for companies that have to manage multiple short term projects together. Such services are also desired by firms working in the education, health, finance sector among many others. If you are an agency who needs to abide by the intermediary reporting requirements or a contractor who needs to find the most tax-effective method to operate as a contractor you should try finding an accounting firm nearby, a contractor accountant, an online accountant or a tax accountant who can help you with smart solutions and keeping compliant.

What do you need to know about a freelancer?

A contractor may be limited to a single contract if the contract so requires for a specified period of time but freelancers are under no obligation to serve a single client, they usually service multiple clients together without any specified time period and generally without extremely strict contractual terms. Freelancers have the freedom to work from home and can work whenever they want to, as long as they are able to work and complete their tasks on time. They may have a fixed rate per project or may charge their clients on an hourly basis.

Freelancers are usually found providing services within the creative and consultancy sector, where they are appointed to produce a product or service. For instance, a consulting agency may hire a freelancer to provide content for the articles on the topics the agency plans to work on. 

Freelancers are paid at the end of the completion of their service within an assigned deadline. They may be working with a number of clients together at the same time but it is their primary responsibility to ensure that they complete their work in a timely manner or otherwise face deductions in the payment that is agreed.

Freelancers usually provide services of content writing, graphic designing, architecture and many other services in the creative industry. Freelancing is a highly popular means of earning income among students and employees, due to the flexibility of commitments and conditions it is subjected to. Freelancers generally work as self-employed individuals and submit their personal tax return to HMRC, if you are a freelancer you should make sure you have a highly competent personal tax accountant, contractor accountant or contractor accounting firm appointed by you to help you work tax effectively.

How do freelancers and contractors work under a recruitment agency, an umbrella company or a limited company?

Contractors and freelancers may choose to either work as a sole trader or a limited company. However, the way each one operates is different and it’s important to understand the differences between the two:

Recruitment agencies

Contractors working through recruitment agencies, do not directly receive income from their contracting clients for the services they have provided, instead clients pay the amount to the recruitment agency along with the service charges. Agency then pays the contractors as the worker of the agency or an employee. This is where the intermediary reporting rules come in for the recruitment agencies. If you are an agency, hire a specialist contractor accountant to help you with your reporting needs.

Freelancers are directly paid by their clients through invoicing, as most of the times they are not even enrolled on an agency’s payroll.

Umbrella companies

Contractors may opt for working under an umbrella company. Umbrella companies serve as the link between the contractors and contracting company. Working under an umbrella can bestow many time-saving benefits, as they only take invoices into account and convert them to salaries but an umbrella itself will never provide employment or hiring opportunities to the contractors or freelancers.

Freelancers are directly paid by their clients through invoicing as they are not required to be set up on payroll and are considered ineligible for IR-35. If you cannot decide between working as a freelancer or a contractor, speak to a contractor accountant for guidance.

Limited Companies

Contractors or freelancers working through a limited company can maximize the income they take back home by taking on different positions that are available in the company’s hierarchical structure. Their income is first paid to the company and they are then able to withdraw the income if they fulfil their role either as a shareholder, a manager or an employee of the company. Contractors can avoid high-income tax rates by utilising the company to plan how much money to take out and how, such as through salary and dividends or both.

The decision of choosing between working either as a contractor or a freelancer should depend on the industry you have associated yourself with, your personal preferences, the business structure you prefer to work with and the time you have available. However, it is advised that you conduct thorough research before making a final decision, as your future profits, work-life balance and scalability highly depend upon that decision. Alternatively, speak to a contractor accountant for help and guidance.

Clear House Accountants are expert Accountants in London who have years of experience working with contractors and freelancers helping them select the most optimum business structures while staying compliant for tax and accounting. Our team of contractor accountants have been trained by and developed to tackle complex problems and create innovative solutions.

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