The Difference Between Freelancers and Contractors

Freelancer vs Contractors terms are often use interchangeably. This is something employers consider for their tax strategy to save money.

The Office of National Statistics disclosed a report according to which, by the last quarter of the year 2019, there were more than 5 million self-employed individuals in the UK.  

As per the report, self-employment has contributed 3.3% more in the labour market then it did in 2000. 12.3% of respondents were self-employed as freelancers, and 10.2% identified themselves as a subcontractor. Generally, these two categories seem homogenous in meaning, however, there is a difference between freelancing and contracting.  

Contractors and freelancers both come under the umbrella of self-employment. However, both use different mechanisms to offer their services. It is necessary to understand the contrast between the two, even though there is not much difference in terms of tax compliance. However, a few differences can be critical while identifying the tax liabilities and legal rights of both freelancers and contractors. 

The categorisation of freelancing and contracting depends on the industry the individuals are associated with and the method with which their services are offered. 

What is a Contractor? 

Contracting is quite a familiar term to the general public, but not many understand the true nature of it.  A contractor offers services to clients for a predetermined duration of time and gets paid for those services. 

Contracting is not limited to an individual. A contracting organisation can also provide services to other individuals or organisations for a set duration of time. Contractors work based on contracts and are identified as external workers for a client. 

The contracts are legal documentation of terms and conditions, that both the contractor and the client sign. These terms include the nature of the services offered, the income of the contractor is in exchange for the duration of time for which contractor will provide the services. The contract can later be extended if both parties agree on further continuation. 

Such contractors may get the status of short-term employees by the client businesses. During this employment status, the contractors can work within the company on the premises of the company, however, this short-term employment does not require the employee to be added to the company’s payroll. The client company is therefore not responsible for any tax compliance of the contracting company or individual. Contractors are solely responsible for tending to any tax compliance or National Insurance (NI) on their own, unlike other permanent employees of the client company, this is the case for the private sector, for now, the off-payroll rules are expected to bring some changes to this.

How Contractors Connect with Clients 

Professional and technically skilled individuals often operate as contractors like IT and engineering. A vast majority of these individuals work for end-clients through recruitment and contracting agencies. These agencies act as a bridge between the contractors and the strong network of clients searching for such contractors. Most contractors prefer working through their own limited companies or under an umbrella company.  Our specialist accounting team have worked hard at creating an all-encompassing guide which explains the difference between a limited company and an umbrella company.

If the contractors connect with other clients via these agencies and work through them, they may be considered as agency workers, according to the legislation. However, it is only possible once they agree with the contract. As an agency worker, these contractors can secure National Minimum Wage, as employment rights, with few other perks. 

In case, if these contractors sign up for a contract for the “pay between assignments” with the agency, then they can get other supplemental rights and responsibilities as agency employees. Contractors can work with different agencies simultaneously to find them multiple suitable contracts.   

However, it is only possible if the terms of the agreement with the client company allow them to and most probably if the contractor is self-employed. This contract may enable them to enjoy the flexibility of work during this time; however, they will not have any employment rights. 

Video: How To Become Contractor In The UK

Are you wondering how to become a contractor in the UK? Watch the video describing step by step process to become contractor in the UK

Why Companies Hire Contractors? 

Hiring contractors is more efficient and profitable for companies managing multiple short -term projects. While working on short-term projects, companies prefer hiring contractors. As the nature of the project does not demand any permanent hiring on their end. Education, IT, finance,  health and safety sectors with many others often seek such short-term services. 

However, we recommend consulting a local accounting firm or take help from a professional contractor accountant to help tackle any legal or statutory complexities. Even agencies have to abide by the intermediary reporting requirements, a professional accountant may be able to help you find the right way to abide by strict regulatory requirements.

What is a Freelancer? 

A contractor can work for multiple clients if the contracts state so. But if not then a contractor may be obligated to work for a single client for a predetermined duration. However, a freelancer has no such limitations to serve an individual client. They can work for multiple clients on a flexible basis regarding time and contractual terms. 

Majority of freelancers work from home or the comfort of their studios. There is no strictness regarding the working hours as long as freelancers can meet the deadlines and can provide quality services. The income depends on the volume of given tasks and the fixed price for services, or freelancers may charge their clients on an hourly or daily basis.

Freelancing is mostly prevalent in creative and consultancy industries like the graphic design sector, Content writing, journalism, editors, web developers, and other such industries. For instance, an animation company may hire freelance illustrators and animators to complete a project. 

Freelancers usually get their income on the completion of the task within the due time. Time management is the most crucial factor of freelancing as any violation of deadline may result in payment deduction. The freedom to work for multiple clients simultaneously comes with the primary responsibility to ensure timely and quality delivery of the work. 

Students and employees in search of the extra income usually find work while freelancing because of flexible working hours and low commitment demands. Freelancing comes under the umbrella of self-employed; thus, individuals associated with it are responsible for filing and paying their tax returns to HMRC. However, if the complexities of legal factors of tax compliance are overwhelming for you may want to consult tax accountants to sort out your tax effectively.

Work Structure Under Different Companies

As mentioned before the mechanism through which contractors and freelancers offer their services differ, and that is why the way each one operates under different work structures, also changes. Freelancing and contracting can adopt different work structures, sole trader, limited company, umbrella company or under recruitment agencies.

Recruitment agencies

Contractors who sign up with recruitment agencies do not receive income for their services directly from the agency. The client company pays the amount along with the service charges to the recruitment agency. At this point, the intermediary reporting rules come in for the recruitment agencies. 

Intermediary reporting demands agencies to return details of all non-PAYE employees placed with the clients to HMRC. The recruitment agencies are responsible for sending the report once every three months at least. The frequency may depend on the intermediaries whether they want to send it weekly, monthly or once for three months. 

These agencies may need to hire specialist contractor accountants to avoid any complexities of intermediary reporting. Whereas, freelancers get secure payments through invoicing by the clients. There is no third party involvement as most freelancers do not sign up through the agency.

Limited Company

Contractors within a limited company become the shareholders and directors of the company. The positions make them the owner and the manager of the company that brings extra responsibilities other than just completing a project. 

It brings the responsibility of effectively running the company along with managing the complex payroll and taxes. Working under a limited company work structure is suitable for long term contracts. It allows more room for planning the tax and funds extraction as efficiently as possible. You might want to review our business starting guide for trick and tips.

Both contractors and freelancers can maximise the individual income by taking different positions on the hierarchical structure of the company. Their income is first paid to the company, and they are then able to withdraw the income. It is possible 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, such as through salary and dividends or both.

Umbrella Companies

Contractors may opt for working under an umbrella company that serves as the link between the contractors and contracting company. Working under an umbrella can bestow many time-saving benefits and may come with some disadvantages also.  

It is advantageous for contractors that such companies handle all the complicated paperwork, tax deduction and NI before the payment to contractors. This process saves both time and efforts on behalf of contractors. However, an umbrella company will never provide any hiring opportunities to freelancers or contractors. 

Regarding IR35 status, umbrella companies are not at risk as they deal with all transactions and payrolls under PAYE. However, it is essential to make sure if the umbrella company is using any schemes that can be considered as loan charges or other flagged tax avoidance schemes by HMRC. 

In contrast, freelancers are not eligible for IR-35 status as they get payments through invoicing and are completely independent of the client when doing their job. The direct payment method does not require any setup on the payroll. you can also see different options as a contractor to make an informed decision.

It might be easier to hire professional accountants to help you decide the path you want to take on, whether freelancing or contracting. Various factors contribute to finalising the decision like your interest in the respective industry, preference of flexibility and the working hours. The decision can be quite intimidating as it can further affect your future profits, stability, work-life management, and scalability.

Clear House Accountants are professional Accountants in London with years of experience. They work as consultants and service providers to small businesses, high-end companies, contractors, and freelancers. They have helped them select the most optimum business structures, along with efficient tax and accounting compliance and extractions.

You might also want to read: