Contractors vs employees in the United Kingdom

At a glance

Key figures with the official source for each, checked November 2026.

Three statuses, not two

US practice divides people into W-2 employees and 1099 contractors. UK employment law has a middle category, the worker, and most misclassification disputes are about it.

A person is generally a worker if they have a contract to do work personally for payment, have only a limited right to send someone else, and are not running a business in which the other party is really a client.

Status for tax is a separate question. GOV.UK guidance states that someone can be self-employed for tax and still be a worker or employee for employment rights. A contractor arrangement therefore has to pass two tests, one run by tribunals and one run by HMRC.

The legal test tribunals apply

No statute sets out a checklist. The Employment Rights Act 1996 defines the terms briefly and the courts have supplied the tests. Tribunals look at the whole relationship, with weight on three questions:

• Personal service. Must the individual do the work themselves, or can they really send a substitute?
• Mutuality of obligation. Is the business obliged to offer work and the individual obliged to accept it?
• Control. Who decides what is done, how, when and where?

Other pointers include who provides equipment, who carries financial risk, whether the person invoices for completed work, and how far they are integrated into the team.

The written contract is not the starting point. In Uber BV v Aslam the Supreme Court upheld a tribunal finding that drivers were workers even though the documents described them as independent contractors. A substitution clause that is never used, or a statement that the person is self-employed, carries little weight against the facts.

GOV.UK lists indicators of real self-employment: the person bids or quotes for work, works without direct supervision, invoices for it, and pays their own tax and National Insurance.

Tax status and the off-payroll working rules

Where a contractor supplies services through an intermediary, usually a personal service company, the off-payroll working rules in ITEPA 2003 apply. They are commonly called IR35 and work contract by contract.

• Who decides. A medium or large client, or any public authority, decides the contractor's status for tax. For a small private sector client, the contractor's company decides.
• Size test. HMRC guidance treats a client as medium or large if it meets 2 of 3 conditions: turnover above £10.2 million, balance sheet total above £5.1 million, more than 50 employees.
• Status Determination Statement. The client must give its conclusion and reasons to the contractor and to the party it contracts with, whether the result is inside or outside the rules.
• Disputes. The client must answer a disagreement within 45 days.

If the engagement is inside the rules, the deemed employer deducts income tax and employee National Insurance from the fee and pays employer National Insurance at 15%, plus Apprenticeship Levy where relevant. The contractor does not gain holiday pay or other employment rights from the client as a result.

HMRC's CEST tool gives a status view, and HMRC states it will stand by the result if the inputs are accurate.

A US company with no UK presence

The client-side rules contain an exception that matters to US buyers. HMRC guidance states that where the client is wholly overseas, meaning it is not UK resident and has no UK permanent establishment, the off-payroll client rules do not apply. The contractor's own company then has to decide whether the engagement is inside the rules and account for the tax itself.

That exception is narrower than it looks.

• It covers tax only. A tribunal can still find that the individual is a worker or an employee of the US company and award holiday pay, minimum wage arrears or unfair dismissal compensation.
• It assumes an intermediary. A sole trader engaged directly, who is in substance an employee, raises a PAYE question for the engager.
• It depends on having no UK presence. A UK branch, office or subsidiary that receives the services brings the client rules back.
• Contractors can create presence. Someone in the UK who habitually concludes contracts for the US company can raise a permanent establishment question for corporation tax. That is a separate analysis.

Employing the person through an EOR removes the status question, because the individual becomes a PAYE employee of the EOR.

Penalties and back-payments

Misclassification produces two separate bills.

Tax. Where HMRC decides that someone was an employee, or that an engagement was inside the off-payroll rules, the party responsible owes the PAYE and both employee and employer National Insurance that should have been paid, with interest. Employer National Insurance is now 15%.

• Assessments can normally go back 4 years, 6 years where the loss arose from careless behaviour and 20 years where it was deliberate.
• Penalties for an inaccuracy are 0% to 30% of the extra tax for lack of reasonable care, 20% to 70% if deliberate and 30% to 100% if deliberate and concealed.
• A client that gives no reasons for its determination, or misses the 45 day reply, becomes responsible for the contractor's tax and National Insurance.

Employment rights. A contractor found to be a worker can claim paid holiday, the National Minimum Wage and protection from unlawful deductions. A contractor found to be an employee can also claim notice, redundancy pay and unfair dismissal. Workers may also be entitled to Statutory Sick Pay and statutory family pay.

From 1 October 2026 most tribunal claims can be brought within 6 months, up from 3.

Recent law changes and enforcement

Two points follow for 2027. Companies near the old size limits may become small for off-payroll purposes, which moves the status decision back to the contractor's company. And using an umbrella company no longer moves the tax risk away, because the liability now follows the supply chain up to the agency or client.

The government has not legislated a single worker status. The three-tier structure remains.

When a contractor is safe and when to convert

A contractor engagement is at its lowest risk when the facts match the label. Typical features:

• A defined project or deliverable with an end date, priced by quote
• The contractor chooses how, when and where to work
• A real right to substitute, or a team that delivers the work
• Their own equipment, insurance and other clients
• No line manager, no company job title, no place in the organisation chart
• Invoices for completed work, with no paid holiday or sick pay

Signs that the relationship has become employment:

• Full-time, open-ended work for one client
• Fixed hours and attendance at team meetings as a matter of course
• Managing staff or representing the company to customers
• A monthly fee that does not vary with output
• Renewals that have rolled on for a year or more

When those signs appear, the usual step is to end the contractor agreement and offer employment, directly or through an EOR, on a clean start date. Conversion does not erase past exposure, but it stops it growing. Records of the status assessment should be kept, since an HMRC enquiry can open years later.

Frequently asked questions

More on hiring in the United Kingdom

Employer of record and hiring guide for the United Kingdom · Payroll and taxes · Termination and notice · Benefits and leave · Cost calculator · EOR vs PEO vs entity

Sources

• GOV.UK, Employment status
• GOV.UK, Employment status: worker
• GOV.UK, Employment status: self-employed and contractor
• HMRC, Understanding off-payroll working (IR35)
• HMRC, Off-payroll working for clients
• HMRC Employment Status Manual ESM10006A
• HMRC, Umbrella company market: changes to Income Tax rules
• UK Supreme Court, Uber BV v Aslam [2021] UKSC 5

This page is general information, not legal, tax or immigration advice. Rates, thresholds and procedures change, and how they apply depends on the facts. Confirm current figures with a qualified adviser or with Dryft before acting. Checked November 2026.