When Does a Contractor Become an Employee in the UK?

In the UK construction industry, the use of self-employed contractors and subcontractors is often essential. They bring flexibility and expertise to a project, but understanding the legal line between self-employment and employment is crucial - because crossing it has serious consequences.

When a contractor starts behaving like an employee, you run the risk of HMRC reclassification. This can result in backdated tax liabilities, fines and even legal action. At Contractwise, we’re a leading Construction Industry Scheme (CIS) payroll firm that protects contractors and subcontractors by providing services that keep everyone compliant. This includes payroll audits that assess your payroll and ensure everyone is classified correctly.

So, when does a contractor become an employee in the eyes of HMRC?

Let’s break it down…

Why is it important to get employee status right?

Misclassifying a contractor as self-employed when they are, in fact, an employee can have serious financial and legal consequences.

HMRC pays close attention to employment status. So, if a review or investigation reveals that someone working under the guise of a contractor is actually a functioning employee, you’ll be in trouble. HMRC can:

• Demand backdated PAYE tax and National Insurance contributions

• Impose penalties and interest

• Trigger investigations into other workers, which may result in more fines

• Exposes you to employment tribunal claims, including unfair dismissal, holiday pay and pension contributions

Additionally, it can damage your company’s reputation and strain relationships with other contractors or labour recruitment agencies. This is especially relevant in the construction industry, where the Construction Industry Scheme’s (CIS) use of subcontractors is widespread. As a CIS payroll company, the team here at Contractwise helps contractors stay compliant while also understanding the distinction between contractors and employees.

What defines an employee?

There’s no single litmus test that definitively determines whether someone is an employee. Instead, employment status is judged based on the real nature of the working relationship between the two parties. HMRC and employment tribunals look at several key factors:

Personal service

An employee must provide their work personally. They cannot send someone else to do the job on their behalf.

In contrast, a contractor (especially if they are bona fide) may have the right to substitute themselves with another qualified individual. If this right of substitution is not present and the work must be carried out by a specific individual, then it leans towards employment.

Mutuality obligation

This refers to the obligation the employer has to provide work and the obligation of the individual to accept it.

An employee would typically expect a regular flow of work and is required to perform tasks as directed. A self-employed contractor will not have this same ongoing expectation. Instead, each project or task is separately agreed upon.

Company control over an individual

The more control a company has over how, when and where the individual works, the more likely it is that the person is an employee.

Control includes aspects like:

• Set working hours

• Specific instructions on how the work must be carried out

• Being closely supervised

• Being managed alongside staff

A contractor should be free to carry out their work how they see fit, using their own professional judgment and experience to get the job done.

Contractual agreements

Within contracts, it will usually state employment status. While written contracts do matter, what matters even more is the reality of the working relationship.

If a person has a contract that states they are self-employed, but they still work like an employee, then HMRC will look beyond the document. This is known as looking at the ‘actual working practices’.

When does a contractor become an employee in the UK?

The line between a contractor and an employee can be thin. Let’s look at when that line can be crossed:

Hours are decided for them

If you set strict working hours and expect contractors to be on-site between them, you’re starting to tread into employee territory. Contractors are usually allowed flexibility when it comes to working hours.

They work solely for one organisation

While some contractors may choose to work for a single client at a time, if someone consistently works exclusively for your business, it could signal a dependent working relationship.

A true self-employed contractor can offer their services to multiple clients - even if they don’t always do so in practice.

There is an expectation of work

If a contractor expects to be offered continuous work or feels obliged to accept every job you have, it can reflect the mutuality of obligation that we discussed earlier. This is a hallmark of employment.

Contractors should be engaged on a task-by-task or project-by-project basis, with clear start and end dates for their involvement.

Company equipment is used

Providing PPE is generally acceptable for both employees and contractors. But, if your contractors are consistently using your tools, machinery, vans or computers every day, HMRC could argue that they are integrated into your workforce like employees.

They’re on payroll

One of the clearest signs of employment is being paid through payroll systems. This is especially the case if tax and National Insurance are deducted at source.

Contractors should instead be paid gross or under the CIS scheme, and should be managing their own tax responsibilities themselves. If you’re deducting PAYE and issuing payslips, you’re treating them like employees.

Final Thoughts

In the UK, a contractor can become an employee not through a contract, but through how they are treated in practice. The construction industry is under particular scrutiny due to the prevalence of self-employment under CIS, making it more important than ever to get things right. Any missteps can lead to costly HMRC reclassification, resulting in tax penalties, legal claims and impacting your business in devastating ways.

At Contractwise, we specialise in helping construction businesses navigate the complexities of CIS payroll - ensuring our clients are always HMRC compliant. Whether you’re hiring subcontractors or reviewing your existing relationships, we’re here to keep you on the right track. Get in touch today to find out how we can help you stay protected.