Contractor or Employee – what’s the difference?

Hiring help for your business?

When it comes to employment status, there are two main types: employee and self-employed contractor.

Employees have to provide their work personally, they have regular or guaranteed hours they must work with their employer, and they’re under a good degree of control and direction by their employer.

A self-employed person is a person who works for their own business and may provide services to a number of different companies.

It’s important to identify who is an employee or who is self-employed because each has different rights under employment law.

Employees have the most rights,  and the self-employed hardly any.

Get this status wrong and you could find yourself facing unanticipated legal obligations and significant costs.

So let’s try and shed some light on this topic.

 

Who’s an employee?

 

An employee works under an employment contract (otherwise called a contract of service) and does the work themselves (rather than outsourcing it to someone else).

While there are lots of different types of employees, from full-time to part-time and flexi-time employees, each must have work available to them from their employer, and they’re obliged to accept the work.

Employers are entitled to have the final say in how, when, and where the employee’s work is completed.

Employees’ tax and PRSI contributions are paid from their wages by their employer.

 

What’s an employee entitled to?

 

  • Right to a written statement of their main terms of employment from the first day of their employment
  • National Minimum Wage and the protection against unlawful wage deductions
  • Statutory minimum level of paid holiday and rest breaks
  • A maximum of 48 hours on average per week of worktime (although employees can choose to opt out of this right)
  • Statutory Sick Pay
  • Emergency time off
  • Rights to ask for flexible working (note: not a right to be given it)
  • Not be discriminated against unlawfully
  • Protection for reporting workplace wrongdoings (whistleblowing)
  • Be provided with the equipment required to carry out their tasks
  • Health and safety regulation in their workplace
  • Be treated the same whether they work on a part-time or full-time basis
  • Maternity, paternity and other rights
  • Minimum notice periods
  • Unfair dismissal protection
  • Statutory Redundancy Pay

 

Key advantages of hiring an employee

 

  • As the employer, you’re in control of the employee’s work, and you’ve got the final say in how, when, and where it’s completed
  • You own all the products and opportunities that the employee creates
  • An employee must perform the work you’ve assigned personally (rather than outsource it to someone else)
  • An employment contract doesn’t have to be for a fixed term. It can be ended by a notice period, which means that you and the employee have some long-term security and commitment so long as both parties are happy with how things are going

 

Key disadvantages of hiring an employee

 

  • Hiring an employee brings the biggest financial and administrative burden. While it can seem more expensive to hire a self-employed contractor, it’s often more expensive to take on an employee. There are several non-salary related costs, including having somewhere for the employee to work and buying IT equipment, paying PAYE, PRSI, employer’s liability insurance, and holiday and sick pay.
  • As the employer, you’ll need to set up an administrative system to deduct PRSI contributions and Income Tax from the employee’s wages and pay them to Revenue each month.
  • If you’re not satisfied with the quality of work from the employee, you can’t simply end the employment contract or serve the employee with notice. You’ll need to address this through the capability procedure. This can potentially be time-consuming and stressful.
  • An employee has the most employment rights of all the types of help you can hire. This means that there’s the potential for the employee to bring a range of claims against you, for example, unfair dismissal or sex discrimination.

So, taking into account the key upsides and downsides, you may only want to hire an employee if you know you have a steady and long-term stream of work and if you consider that it’s likely the employee is worth the investment and likely to meet your expectations of the work you need completing.

If you’re taking on help for the first time and you’ve made the decision to employ someone, don’t feel overwhelmed.

Take a look at our step-by-step guide to hiring your first employee.

 

Who’s a self-employed contractor?

 

A self-employed contractor is self-employed as either a sole trader or as a part of their own limited company and works under a contract for services that details the rights and responsibilities between the self-employed person and their client.

Self-employed contractors can choose what work they do, and they can decide when and where they complete the work.

They are able to outsource work to others, they provide their own work equipment, and they often work for more than one client at a time.

They’re responsible for arranging their own tax and PRSI contributions.

A self-employed contractor is entitled to:

  • health and safety regulation in their workplace
  • protection against being discriminated against unlawfully

They have far fewer rights than an employee.

 

Key advantages of hiring a self-employed contractor

 

  • you can claim back VAT if the self-employed contractor charges VAT;
  • this is a more flexible arrangement than in the case of an employee. If the contractor’s work isn’t up to scratch, for example, this would be a breach of contract, and you can end the contract immediately;
  • there are fewer financial and administrative costs involved than hiring an employee because you don’t have to pay the non-salary related costs relevant to hiring an employee. Nor do you have to enrol a self-employed contractor into a pension scheme; and
  • a self-employed contractor has far fewer employment rights than either an employee or a worker so you’re far less vulnerable to the individual bringing a claim against you.

 

Key disadvantages of hiring a self-employed contractor

 

  • you’ve limited control as to how the contractor goes about their work. They can choose what work they do, and they can decide when and where they complete the work;
  • the contractor can outsource the work you have asked them to do to someone else;
  • you could face hefty fines from Revenue if the relationship which you thought was a contractor arrangement is deemed to be an employer-employee one. A lot of businesses get this wrong. The Revenue penalises relationships that should be employer-employee but are wrongly described as arms-length independent contractor arrangements.

As a contractor, you’ll typically contract your services by one of two means: by operating as a sole trader and contracting your services in your individual capacity or by setting up a limited company and contracting your services through your company.

In both cases, it’s important to ensure your relationship with your customers maintains an arms-length distance between you, meaning that it’s properly a relationship between two fully independent parties that’s ‘off-payroll’, not a disguised (or inadvertent) employer-employee relationship.

 

What makes a relationship one of employment?

 

The main determinative factors

There are three principal factors that generally point to a contract being one of employment and not a contract for services…

1. No right of substitution

The hired person does not have the ability to appoint a substitute (someone else) to carry out their contractual duties in their place.

Employees do not have this right and instead offer a personal service that’s firmly attached to them as individuals.

They have no power to get someone else to do their work for them.

Contractors should ensure that they’re freely empowered to exercise the right of substitution and that their contract does not say that they will be the only individual to carry out the contracted duties.

There are various different kinds of substitution clauses for contracts for services.

An absolute one, which essentially says that the contractor is entirely free to appoint a substitute and the customer will have no say in the choice of appointee, is, in reality, unlikely to be palatable to most customers.

More common and generally acceptable is wording that empowers the contractor to appoint a substitute, and although the customer is allowed a veto right over the identity of that substitute, the wording of the clause makes clear that this veto can only be exercised reasonably, with the objective of ensuring that the substitute has the appropriate technical and professional skills for the contracted work.

The clause should also make clear that the customer’s consent to the substitution will not unreasonably be withheld.

So, playing this out, if the contractor wants to get someone else to perform their contractual duties, and that person is suitably qualified for the work in question, the customer should not be able to reject the arrangement

It can also be helpful for contractors and their customers to agree on exactly how a substitution would work.

You don’t need to have a substitute in mind; simply agree on a straightforward procedure for how the contractor might appoint someone else and what the customer would do in response, assuming that the substitution was agreed.

This detail might cover, for example, how the substitute would be provided with access to any materials, premises, briefings, etc.

The details could be appended to the contract for services as an additional annex, or they could be set out in a side letter that runs alongside the agreement and confirms what you both intend to be the practical arrangements that would apply if this situation arises.

This kind of letter is often called a ‘real arrangements’ letter.

It is not legally required, and neither is it intended to be legally binding of itself.

But it is helpful in evidencing the intention to ensure the contractor’s ability to put in place a substitute as a very real and manageable reality within the relationship.

Whether you include this level of detail in an annex to your contract for services, or in a side letter, you can adapt our template letter to substitute a consultant  to help you cover off what you’d need to action in your particular situation.

You should also ensure that any substitute assigns to you any intellectual property rights that may be generated in the work they do for you under this arrangement.

You can use our short but effective template letter assigning intellectual property generated by an individual consultant for these purposes.

2. Balanced contractual obligations (often called ‘mutuality of obligations’)

Between an employer and employee, there’s a mutual set of obligations, and it’s generally pretty well balanced: the employer agrees to provide consistent and paid work, and the employee personally commits to carry out that work on an ongoing basis.

Genuine self-employed contractors do not follow this pattern.

The wording of contracts for services should specify start and end dates (not indefinite or rolling arrangements), they should be project- or task-specific (not a list of general ongoing duties), and there should be no obligation on either party to offer or to accept the work during the term of the contract – so that if, for example, the customer does not have work for the contractor on a particular day, there is no obligation for the customer to offer something else or indeed to pay the contractor for that day.

Equally, if the contractor has other commitments on a particular day, then generally, they must be free to honour them, provided that this does not render their contracted duties unperformable.

Another thing to note is that employees have a statutory right to a minimum notice period – and so employment contracts normally include a notice period and often a payment in lieu of notice clause.

Self-employed tend to be engaged until the project is finished but can be dismissed for breach of contract.

In addition, a genuine self-employed contract wouldn’t have employee rights such as sick pay included.

Often, for genuine contractors, project work will be done on a fixed-price basis, though potentially with milestone payment stages built into the scope of works so that the contractor does not go unpaid for long periods, where the project takes a reasonably long duration.

A contractor’s ability to evidence that they are able to manage their own contract timings, output and delivery risk factors can be very helpful evidence of a genuine arms-length relationship.

3. The customer is the controlling party in the relationship: actively supervising, directing and calling the shots

If there’s a sense of ‘master and (paid) servant’ about the relationship, there’s a strong risk that this will be an employment contract.

This is one of the most significant factors when Revenue determines if an employer-employee situation is present.

Contractors must have as much control over how they perform their contractual duties as is reasonably possible.

If you think about it, they’re typically appointed as an expert in what they do, so they should be advising the customer, following receipt of a brief, and not simply following a set of customer instructions that any employee could be directed to perform.

So, for example, if a client dictates what, when, where and how the work is carried out, it’s very likely that the contract risks being considered one of employment.

If a contractor is provided with broad contractual goals and timescales, e.g. “draft us five different blogs on dog-training techniques by the end of the month”, and also broad freedom regarding how they will write and present those blogs, the arrangement is far less likely to raise suspicions of an employer-employee relationship existing.

By contrast, someone who is instructed to undertake specifically detailed tasks that relate to activities arising daily within the customer’s business or who is given a very detailed job description reflecting broadly ongoing tasks looks far more as though an employment relationship is in place.

Having said that, signing the necessarily exacting terms of confidentiality agreements, abiding by, for example, a customer’s health and safety, data protection, anti-bribery and corruption and bullying and harassment policy rules, plus other security rules, even complying with the customers’ existing brand guidelines, should generally not give rise to any employer-employee impact.

If all of these factors are clearly met, the contractor is most likely an employee and Revenue penalties will likely apply.

Other arguments are likely to carry little weight in dissuading Revenue that this is not, in fact, an employment contract.

 

Other indicators of employment and not contractor status

 

Where the position is less clear, other factors may be taken into account by Revenue, including…

a) no risk is taken by the individual

Normally, contractors take financial risks that employees do not.

One obvious example of this is that contractors invoice for their services and, therefore, bear the risk that they might not get paid on time or at all for the work that they’ve done.

But of itself, this is not the most compelling of all financial risks that Revenue will take into account.

Others include the risk that where the customer is not satisfied with the end-result of the work that the contractor has done, the freelancer/contractor will typically be contractually obliged to fix the problem at their own expense.

No pay for time off (for whatever reason), no assurance of consistent work, having to cover printing and equipment costs, having to take out insurance cover, costs of office space, etc., are all further examples of how genuine contractors bear greater financial risks than employees – for whom all of these elements are paid, (in many cases, they are legally required), and they are typically taken for granted.

A big risk contractors take is that work may be unreliable or dry up.

Employees are assured of protection in this event, or redundancy rights if the reduction in work levels endures.

b) the worker is not ‘in business on their own account’

The contractor should be running their limited company and operating just like any other business.

This means, for example, that they should have a registered office address, business bank account, and insurance and be making their obligatory filings (to Revenue and the CRO).

They can be expected to have other clients, past and (potentially also) present (i.e. at the same time as the work they undertake for their current customer).

They may have their own business premises or somewhere from where they typically run their business activities, VAT registration, business cards, their own website, undertake marketing activities, and have independent financing arrangements, e.g. via a loan, grant or investors.

All of these factors go to show that a contractor is genuinely self-employed and not working via a structure that is simply designed to avoid paying the taxes that employees and employers must pay.

There’s no one-size-fits-all approach here, but every element of independence helps.

c) equipment is provided

Employees will usually have all the equipment that they need provided to them, or they are likely to benefit from reimbursements/expenses arrangements where they are using their own equipment for work, e.g. phone bill and rental contributions made where they are using their own phone for work, travel and/or fuel expenses reimbursed where they use their own travelcard to travel, or they use their own car and need to buy petrol to travel for work.

For a contractor to be using client laptops, mobile phones and cars and seeking reimbursements may suggest a closer than comfortable nexus to an employment relationship.

If a contractor were to enjoy other employee-relevant benefits, like subsidised gym membership, or subsidised food in a staff canteen, etc. these would also indicate a non-arms-length relationship.

d) no requirement to keep records of your activities and charges

Contractors should keep records – not least to demonstrate to Revenue if ever asked, that they are managing their independent business responsibly and they are not relying on anyone else to do so for them, which could indicate a relationship of reliance more akin to one of employee and employer.

Employees rarely need to keep records and to the extent that they do, they tend to be able (or obliged) to do so using systems or arrangements that their employers have imposed on and made available to them.

e) single customer focus and integration

An employee will usually only have one employer at any one time.

Contractors will often have several customers, at least, and it will often be the contractor that sets the timeframes and expectations around when they can deliver for each of those customers.

Contract lengths are not conclusive of anything in their own right, and it is quite possible for a contractor to work for a customer for many years without the risk of an employment relationship overtaking their original intentions.

Having said that, the longer a contractor works for one single customer, the harder it may become for them to demonstrate that they are still in business on their own account and have not, in fact, been absorbed into that customer’s business.

Factors that might point to a contractor having essentially become ‘part and parcel’ of their customer’s organisation may include being expected to train others and/or run teams and functions, to attend management or board meetings in a regular and full-session capacity, or to stand in for other persons (who are employees), where those persons are unable to attend meetings where they would be representing the customer’s business.

However, having an email address that is associated with the customer’s business is generally not considered of itself to indicate employee status.

To help get it right, check our useful checklist

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