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Last updated: 02.03.21

Contractor vs Employee - What's the Difference?

There are many different types of employee that might be part of a business at any one time, each with different job expectations and specifications. Whilst many of the most effective workforces are made up of a mix of permanent and contract staff, many people are unsure of what actually makes these two roles different.

As a business owner in particular, it is important to understand the legal and technical differences between hiring an employee and a contractor, as well as understanding which situations are best suited to working with each.

What is a Contractor?

A contractor can also be known as a freelancer, independent contractor or a consultant. They are a self-employed individual who carries out work for a business over a defined period of time and then moves on to another role.

Most contractors are specialists in their industry and have knowledge or skills that are highly desirable. Because of this, they are frequently brought in to advise or assist with a certain project, or to complete a section of work that requires certain experience and abilities. There are times however when a contractor may not be a specialist and instead have been brought in to cover the work of an employee who is on extended leave.

What is an Employee?

An employee is a long-term, permanently employed member of staff who is contracted to receive and complete work for their employer on a regular basis. Their working hours and days will be determined by their employer, and their pay will be based on an annual salary or hourly rate.

Whilst there is a growing trend towards working as a freelancer, the majority of people are either permanent or part-time employees at a place of work. In most cases, this comes with benefits such as job security, health insurance, sick pay and holiday allowance.

What is the Difference between an Employee and an Independent Contractor?

Whilst the technical specifications of permanent employment and contract work can be tricky to determine, there are several factors which help to establish the key differences between the two types of workers. 

Contract Agreements

Perhaps the key difference between a contractor and an employee is the employment contract that binds the individual to their work.

The commitment that an employee makes when joining a company is usually permanent and long term, with their employer agreeing to provide them with regular and ongoing work. An employee will also have to state that they will not carry out any work for another employer during their time at the business.

A contractor however has no permanent commitment to the company that has hired them, and tends to only work for a business for a short time or the duration of a single project. They have a right to turn down jobs that are offered if they wish, and can often negotiate their own terms of work.

Obligation

One of the factors used to legally determine whether a worker is an official employee is the obligation that they have to their place of employment. 

Contractors have no obligation to accept the work that a company might approach them with, and even whilst working for a business they do not have the same level of commitment as a permanent employee. They can also work for several different businesses at once if they have the resources, and have the freedom to choose which task they wish to prioritise.

Employees, on the other hand, are bound by their contract to complete all the work that is given to them and are also expected to be committed to producing the best possible work for their employer.

Legal Rights

The legal rights for an employee are quite different from that of a contractor, which is why many people feel more secure working in a position of permanent employment.

Employees have several legal entitlements, including protection against unfair dismissal, the right to statutory leave, paid annual leave, time off for emergencies and the chance to join a pension scheme. These rights mean that they have a lot more job security and cannot lose their job suddenly without appropriate reason and notice.

Contractors on the other hand have very few legal rights when it comes to their employment, and do not have to receive things like paid annual leave from the company who they are working for. Certain laws such as data protection and health and safety do still apply to contract workers however, so the role is not entirely unprotected. 

Role Control

The level of control that a worker has over their job can depend on the company they work for and their level of responsibility, but there are significant differences between contractors and employees.

As a freelance worker, a contractor has the right to decide their own working hours, holidays and the type of services that they offer to potential clients. They are not bound to fulfill any specific role obligations and can manage their own schedule as they see fit.

Employees have the specifications of the role outlined by their employer, and are bound by their contract to fulfil these obligations. Most employees will have their working days and hours decided for them, and must complete all tasks requested by their employer.

Level of Skill

A key reason for a business owner to decide to hire a contractor instead of a permanent employee is because they are looking for a specific level of skill that they need instantly, which is why contract workers are often in very high demand.

Employees may arrive at a company with specific skills that got them the role, but the role specifications often require the execution of more general and administrative tasks as well. Many companies provide training programs and development resources to help their employees grow, but this is seen as a long-term investment and employees are often required to take part.

Contractors frequently decide to become freelancers because they have unique skills and experience that make them an expert in their field. This allows them to offer these skills, either as a consultant or a temporary staff member, to a range of different companies and only work on projects that genuinely interest or challenge them.

Tax

A simple difference between contractors and employees is the way in which they pay tax on their earnings.

Contractors are in charge of handling their own taxes after every job they complete, as companies working with contractors do not have to calculate any deductions before payment. The amount of tax that employees pay is handled by their company, generally by using a PAYE system, and not additional input is needed. 

Role Substitution

As an employee, you are legally bound to carry out all the work that you are given, and cannot send in someone else to take over your job. A contractor however has no such obligation, and can hire any number of other people to do their work for them or exchange tasks within a team.

It is here that the difference between a contractor and a subcontractor is defined; subcontractors are managed by a freelance contractor and may be sent in the place of a contractor to complete a job.

When do you need a Contractor?

In many instances, a contractor is hired if a consultant or an individual with specialised skills is needed for a project. Whilst it is possible to train internal employees to possess these skills, it is often faster and more cost-effective to simply outsource work to someone who is a trusted expert and can begin a task immediately.

Contractors can also be helpful during busy periods at a business where a permanent team cannot handle all of the work required. If you are a business that completes one-off work for clients instead of providing regular services, you may find it more effective to simply hire contractors during busy periods and keep a smaller team of staff permanently employed.

Another situation in which working with contractors is the preferred option is when a company is just starting out and may not yet have the budget and resources to hire multiple permanent employees. Outsourcing work to contractors whilst your business grows is a good way to keep on top of work, and you can always hire a contractor as a permanent member of staff once you have more financial stability.

Advantages of hiring a contractor are that their role can be flexible, they bring experience and knowledge to a business that it might not have otherwise had access to, less management and direction is required and it can often be the most cost-effective short-term solution for a project or period of work.

Disadvantages of hiring a contractor however are that they may not prioritise your work if they have multiple jobs to complete, they can often be hard to contact as they don’t work regular hours, and if you are unsatisfied with their work it can be hard to terminate a contract early without legal input. 

When do you need an Employee?

An employee is hired when a business needs someone new to fill a role that has been vacated, when a new role is created in the company or if you review your business’s workload and decide another full-time member of staff is required. If you want to expand your company and develop a team of individuals who work well together then hiring a permanent employee is usually the best option.

Advantages of permanent employees are that they allow you to build a stable and effective team that understands how the business works, it is easier to allocate tasks and workloads and you can invest time and resources into their career development to end up with an incredibly valuable team member. 

Disadvantages of hiring permanent employees are that they are more of an investment in a business to begin with, the recruitment process can be very time consuming and costly, you may miss out on gaining specific skills and experience by hiring for a full-time role, and a permanent contract can be difficult to terminate if an employee doesn’t work out in your company. 

FAQs

Are contractors self employed?

In many cases contractors are self-employed, and manage their own work by either approaching companies offering their services or getting their name out there in the industry and waiting to be sought out. The freedom of this style of employment is what attracts many people to become independent contractors, although it does mean taking charge of your own finances and negating your own terms of employment for each job.

There are many recruitment agencies who also hire out contractors and are in charge of finding their next roles. A lot of these contractors will still be self-employed, but will just be part of an agency to make finding work easier. 

When is a contractor considered an employee?

There are four factors that determine whether an individual is an employee, which will be reviewed if a decision is being made about their employment status. If an employer controls all of an individual’s work, they are fully integrated into the business, they receive consistent pay and tasks and there is considered to be a mutual obligation of work between them and the employer, the individual will likely be classed as an employee and not a contractor. 

The change from contractor to employee usually only happens if a contractor has been working for a business over a long period of time and has become more involved in the daily working of a company.

What is the difference in pay between an employee and an independent contractor?

In general, an employee will receive an annual salary from their employer whereas a contractor may either be paid per job or per hour of work that they complete. Whilst contractors generally get paid more than employees for the work that they do, permanent employees have more financial and job security because of the permanent nature of their employment.

Summary

Whether you’re reviewing the job status of a current employee, deciding on what kind of worker to add next to your current team, or considering working with contracted suppliers, we hope this guide has cleared up the differences between being an employee and a contractor.

We have a number of different contract and business compliance online courses available here at Virtual College, including ‘Managing Remote Teams’ which offers clear and concise guidance on working with people remotely.

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