Deciding what sort of workers to take on as your business expands is critical to future success. Increasing the headcount too quickly, pushing up fixed costs without also generating higher revenues is a quick way to close a business. On the other hand, relying on subcontractors who may be unavailable at the time of greatest need, unreliable or whose work is unsatisfactory will greatly constrict your ability to grow.
But there is no simple answer as to which is better: employees or subcontractors. What will be the right choice for one company may not be for another. Each has its pluses and minuses.
In addition, there are legal and tax pitfalls to misclassifying your workforce. If contractors are found to be employees that opens you up to all sorts of liabilities, such as having to defend an unfair dismissal claim.
HMRC’s tax take from an employee is higher than it is for a subcontractor, for example, employers pay national insurance on employees but not on subcontractors. Thus it is in HMRC’s interests to challenge the employment status of subcontractors. If the challenge is successful it will backdate any taxes and national insurance owed with interest.
Therefore, it is vital not only to make the right decision about taking on employees or subcontractors but also to make sure you have classified them correctly. So, let’s have a look at the distinguishing characteristics of employees and subcontractors.
Who is an employee?
Employees work under direct supervision and control, and have an open-ended employment contract that gives them fixed hours of work. Employers give them what they need to do the job, supervise how they complete their tasks and deduct their income tax and national insurance.
Who is a subcontractor?
Subcontractors decide when they are working and supply their own tools, equipment and materials. They will often be on a fixed-term contract and are paid by invoice and do not need to be supervised. They are responsible for paying their own taxes and for arranging their insurance cover.
Unlike employees they can hire other people to do the work for them, are not obliged to accept work and will work under their own name or that of their business.
Construction Industry Scheme
Under the Construction Industry Scheme (CIS) contractors withhold pay each month from subcontractors and hand it to HMRC. The scheme only covers work done on a construction site. Even though tax is being deducted at source from contractors it does not give them any employment rights. For a fuller look at CIS see our article CIS tax: what is it and who pays it?
Advantages of employees
Employees come with some compelling advantages. You have control over how they do the job, when they work and the quality of what they do. They are familiar with the business and your expectations, and can be relied upon to participate both in meeting the immediate needs of the business and in contributing to the company’s longer-term future.
In addition, the greater mutual commitment of employment status means staff are more invested in the company’s success – this has benefits for customer satisfaction and team working.
Another plus is that you can train employees so that they have exactly the skills that you need. This ensures work is done to the standard you require and that output is of consistent quality. This investment in staff should be repaid by good retention and through having people whose capabilities will grow alongside the business’s success.
Disadvantages of employees
Employees come with a panoply of rights, which recently increased with the Employment Rights Act 2025, some of which they acquire on their first day of work. From October they will be able to bring a claim for unfair dismissal after six months of employment, down from the current two years.
Employees also place you under certain legal obligations: you must register as an employer with HMRC, run payroll and pay their income tax and national insurance and you must take out employer’s liability insurance. It is also essential to check their legal right to work and to give them contracts.
Employees must get at least the minimum wage and holiday and sick pay. In most cases you will need to enrol them in a pension scheme.
Dismissing employees can cause problems for businesses. A dismissal process must be fair and reasonable, and many employers have lost tribunal cases even when there has been underperformance or misconduct because of faults in their process. Employees have gained – and will gain more – additional rights under the Employment Rights Act 2025.
Advantages of subcontractors
Subcontracting work offers great flexibility for businesses that have peaks and troughs in customer demand, and enables them to control fixed costs tightly. And a labour-only subcontractor comes with financial savings as the employer does not have to provide equipment or benefits such as sick leave and paid holiday. Employers also do not have to pay the 15% national insurance contribution that they do for employees.
Administration is kept to the minimum as there is no need to run payroll or set up a pension or go through recruitment or induction processes. In many cases, subcontractor can work remotely, cutting down on workplace costs. In addition, if the subcontractor turns out to be unsatisfactory it should be straightforward to terminate the contract.
A subcontractor is ideal for one-off jobs where the company does not need the contractor’s skills in-house all the time; however, you must make sure that the contractor has insurance.
Start-ups may prefer to use subcontractors until they are confident the business is secure and stable enough for it to be able to take on staff. They can also be left to get on with the job while you focus on expanding the business, unlike a new employee, who will need training and support in the early days.
Disadvantages of subcontractors
There can be a loss of continuity with contractors – their skills and knowledge of your business will depart with them, which might be a problem if there is no one else in the company that can do what they can.
Contractors’ hourly rates will be more than those of your staff so if you end up relying on self-employed workers in the longer term they can be less cost- effective than recruiting another member of staff.
Contractors may not be available when you need them – you are unlikely to be their only client.
They may also have their own way of working and outlook, and may not integrate into the company, which risks creating management problems.
They may also work for your competitors, which could lead to commercially sensitive information about your company falling into the hands of rivals. However, this potential problem can be addressed with a confidentiality agreement.
Types of subcontractor
Especially in construction, there are two sorts of subcontractor: labour-only subcontractors and bona fide subcontractors. The former tend to be paid daily or weekly on standard rates, and are covered by your employer’s liability insurance whereas the latter might be paid in instalments or by means of a lump sum at the end of the contract.
Labour-only subcontractors use your tools and equipment, and are perceived as part of your business so you will be accountable for any quality issues or accidents that arise from their work. That said, they are self-employed and look after their own tax and national insurance.
Bona fide subcontractors will usually quote for a job and will generally use their own tools and equipment. They must have their own public liability insurance and that cover should be to the same value as your own. If their work is substandard they are responsible for rectification.
Labour-only subcontractors will need closer supervision than bona fide subcontractors, who need little control or oversight. You must make sure the former follows your health and safety rules whereas the latter are responsible for their own safety and that of their teams.
What is IR35?
The IR35 rules are meant to ensure contractors pay similar amounts in income tax and national insurance as employees. They were set up to tackle the issue of ‘disguised employees’ who were able to pay less tax than the equivalent employee.
IR35 applies to contractors who provide their services to a company through an intermediary and would be employees if providing their services directly to the employer.
The company through which the services are provided is known as a personal services company or PSC. Contractors are deemed either inside IR35, in which case employers deduct their income tax and national insurance, or outside IR35, in which case contractors work as a standalone business and take care of their own taxes. it is the PSC rather than the contractor that receives payments for work done.
There is no simple test for whether someone is inside or outside IR35; however, the government offers a tool, Check employment status for tax, which will tell you how to classify your workforce.
Whether it is better to use contractors who are inside or outside IR35 is a matter for each company to decide. However, the rules governing IR35 status must be understood fully and applied correctly as HMRC will come after employers that make classification mistakes.
Conclusion
Due to the different tax regimes that employees and contractors fall under it can often be helpful to get specialist advice to ensure compliance with relevant tax and employment law.
Finsbury Robinson offers a full suite of tax, accounting and business advisory services. Our friendly and highly experienced team can be reached on 020 8858 4303 or via email at info@finsburyrobinson.co.uk
