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Contractors, freelancers, and consultants are self-employed individuals who work alone or as part of other businesses. These terms cause a great deal of confusion because they are often used interchangeably when discussing self-employment. However, there are significant differences between the three, which we discuss below.
Generally, the role of a consultant is to advise or consult. These individuals work in a variety of specialist industries and provide professional, expert advice to other people about how to improve their lives or businesses.
Contractors and freelancers, on the other hand, are usually hired by individuals and other businesses to perform specific types of work on their behalf. This could be on a one-off basis or as part of an ongoing or recurring service.
A contractor is an individual who carries out work for other people or businesses in return for a pre-agreed hourly rate or set fee under a contract for services. This differs from the purely advisory role of a consultant.
Contractors are usually professional industry experts, but extensive skill sets and masses of experience are not always essential. The flexible nature of using contractors is sometimes more appealing to clients who simply do not want or need to hire someone on a permanent basis.
Contractors are hired for a fixed period of time to carry out whatever work is required by the client. They tend to work on one project at a time on a full-time basis.
Due to the temporary nature of these projects, clients are not required to provide any employee benefits or guarantee further work. For these reasons, many contractors are able to negotiate very high rates for their services.
What types of work do contractors carry out?
The types of industries in which contractors commonly operate include:
- IT maintenance and support
- Building services and construction
- Gardening and landscaping
- Plumbing and electrical services
- Carpentry and joinery
- Painting and decorating
- Cleaning services
- Property maintenance
- Security Services
- Independent audit services
Given the nature of their projects, contractors generally carry out the majority of work on their clients’ premises.
A contractor will usually operate as a sole trader or set up a limited company, but they can also get fixed-term contract work through recruitment agencies. A limited company is the better choice for contractors who take on high-value contracts or carry out work that has the potential to lead to liability claims. As a sole trader, the contractor would be held personally liable if anything went wrong.
What is the difference between a contractor and a subcontractor?
Contractors and subcontractors are not the same. A contractor provides agreed services to a client for a set fee under a contract for services. A subcontractor provides contract services to a contractor.
A construction company (the ‘contractor’) is hired to build new premises for a client. The contractor hires an electrician and a plumber (‘subcontractors’) to fulfil certain parts of the building project, but only for the duration of that project. The contractor is responsible for hiring and paying the subcontractors, thus he is ultimately responsible to the client for any work carried out by the subcontractors.
A consultant is essentially a professional advisor who works as an independent specialist in a specific field. They use their experience, expert knowledge, and niche skills to offer professional advice to other people or businesses in return for a fee.
Typically, the role of a consultant is to solve problems by assessing a current situation. They provide an outside perspective and offer objective advice and/or make recommendations for improvements based upon their findings. The client will usually implement changes or recommendations themselves.
The consultant is not responsible for carrying out the changes, nor are they usually accountable for the outcome of their recommendations.
The UK consulting industry is currently worth approximately £10 billion (Source: The Management Consultancies Association). Whilst the term ‘consulting’ is increasingly associated with business and management services, there are many different advisory disciplines in which consultants specialise, including:
- Financial Advisory Services
- Operations Management
- Technology (IT) Consulting
- Planning and Strategy
- Human Resources
- Branding and Marketing
- Political or Public Affairs
- Lifestyle and Wellbeing
- Personal Development
- Health and Fitness
- Animal Behaviour
- Child Behaviour
- Interior Design
- Environmental Compliance
Consultants are held in high regard because they are viewed as the most knowledgeable people in their respective fields. As a consultant, you may be able to charge significant fees to your clients for your advisory services, provided that you have extensive knowledge and experience to act in such a capacity.
This is not a role that you can just take on without the requisite skills. It will take time to build your knowledge base and reputation, and you will have to continuously develop your expertise to keep up with emerging theories, strategies, and industry trends.
Freelancers are flexible workers who provide services to several clients at the same time on a short-term or long-term basis for a pre-agreed hourly rate or fixed fee. More often than not, they don’t work from their clients’ premises. They have the freedom to carry out their work from anywhere they please and they communicate with clients via email, video conferencing, or telephone.
A freelancer is usually self-employed as a sole trader or they work through their own limited company. Some freelancers may also be employed full time and carry out self-employed work on the side to earn additional income.
Typically, freelancers work as media and creative industry professionals in the following types of roles:
- Graphic designers
- Website designers and developers
- Actors and musicians
- Filmmakers and videographers
- Marketing coordinators
- Social media experts
- Mobile developers
- Search Engine Optimisation (SEO) specialists
- Sound and lighting engineers
Depending on your skills and knowledge, you may be able to offer consultancy services as a freelancer or contractor as part of your client services. Even if you do not charge your clients extra for your advisory services at first, it is a great way to expand your portfolio and progress into consultancy work on a full-time basis.
Keeping yourself relevant is one of the most effective ways to ensure a successful career in a competitive field and obtain sufficient work across your client base at all times.
Setting up as a consultant, contractor, or freelancer
You can get work in any of these types of roles through recruitment agencies, which means you can be paid and taxed through Pay As You Earn (PAYE). This is something you could do in addition to a full-time job as an employee if you require additional income or wish to build on your experience and move toward self-employment.
However, it is more common for consultants, contractors, and freelancers to operate as self-employed sole traders or via their own limited companies. By doing so, you will be responsible for your own taxes, National Insurance, and accounting, but trading through a limited company will improve your professional image, help you to establish a competitive advantage, and enable you to minimise your personal tax liability.
You can still source work through a recruitment agency even if you’re self-employed.
Benefits of company formation for contractors, consultants and freelancers
1. Legal compliance
- Safeguards against Intermediaries (IR35) Legislation
- Protects against Managed Service Company (MSC) Legislation
- Free from Agency Worker Regulations
2. No intermediary or 3rd party umbrella costs
When you work as a contractor through a large intermediary organisation, they plan and assign your workload, pay you a salary, and maintain your records and accounts. This is great in some respects, but there’s not a great deal of flexibility or control.
If you set up a limited company, you will have much greater control and flexibility because you will be employed by your own company. This will give you the freedom to organise your own affairs, choose your workload, and decide when to pay yourself.
You will also be responsible for maintaining your own records and accounts, but you can appoint an accountant to do these things for you.
3. Financial planning and Tax efficiency
A limited company structure offers more flexibility for paying yourself in a tax-efficient manner. As a self-employed contractor or freelancer, your net profit is liable for Income Tax and National Insurance contributions (NIC) in the financial year it is earned. But as a company director and shareholder, you have the option of deferring tax by leaving some of your profits in the business.
These reserves can be beneficial for a number of reasons:
- You can keep your salary and dividend payments below the higher tax rate thresholds
- You can create a Director’s Loan Account to remove additional funds without facing any tax liabilities
- You will be in a position to react efficiently to any significant changes to the tax system
You can also minimise your personal tax by taking most of your income as dividends, rather than taking all of your income as a salary. These dividends will be paid from profits after the deduction of Corporation Tax.
The annual dividend allowance means that the first £1,000 of dividend income is tax free. You will then pay dividend tax on anything above that amount.
Provided that you do not have other significant sources of income, the best option would be to pay yourself a director’s salary up to the NIC Secondary Threshold (£9,100/year for the 2023/24 tax year) and take the rest of your income as dividends.
Tax rates on dividends are always lower than Income Tax rates on salaries, even if dividends exceed the 45% (additional rate) Income Tax threshold.
Beyond the £1,000 dividend allowance and your annual personal allowance of £12,570, you will pay the following tax rates of dividend tax:
- 8.75% on income up to £50,270
- 33.75% between £50,271 and £125,140
- 39.35% above £125,140
Example: Limited Company vs. Self-employed Contractor (2023/24 tax year)
Your company generates revenue of £50,000 after the deduction of business expenses. You pay yourself a salary of £9,100 and declare gross dividends of £33,129. This means that:
- you won’t pay any Income Tax or Class 1 National Insurance on your salary
- the company pays 19% Corporation Tax on £40,900 (remaining revenue after salary is paid) = £7,771
- the first £1,000 of dividend income is tax-free
- a further £3,470 of dividends is tax-free because of your remaining personal allowance
- you pay 8.75% dividend tax on the remaining dividend income (£28,659) = £2,507.66
Your take-home pay for the year is £39,721.34
Your sole trader business generates £50,000 after the deduction of expenses. This means that:
- the first £12,570 of income is tax free because of your personal allowance
- you pay 20% Income Tax on the rest of your income (£37,430) = £7,486
- you pay £3.45/wk Class 2 NIC on income above the Lower Profits Threshold (£12,570) = £179.40
- you pay 9% Class 4 NIC on income above Lower Profits Limit = £3,641.94
Your take-home pay for the year is £38,692.66
How to register as a sole trader
To set up as a sole trader, you must register for Self Assessment with HMRC. You can do this online in just a few minutes – it is a very simple process.
Thereafter, you must keep accurate records of your income and expenditure, retain invoices and receipts to support these figures, submit an annual Self Assessment tax return, and pay your Income Tax and National Insurance contributions directly to HMRC every year.
This is an ideal structure if you are just starting out as a freelancer and/or providing low-risk services to only a few clients. As you increase your client base and annual profits, you may wish to consider setting up a limited company to take advantage of the professional prestige and potential tax-saving opportunities this structure affords.
How to set up a limited company
To set up a limited company, you will have to register your business with Companies House. This process is known as ‘company formation’ or ‘company incorporation’.
If you choose to register a limited company, your business will be recognised as a separate entity in the eyes of the law, which means you will enjoy reduced personal liability if your company runs into financial difficulty or you are sued by a client.
This is a more desirable option for many self-employed individuals, especially those who deal with high-value contracts or their line of work has the potential to cause harm or damage to other people or property.
If anything goes wrong, your personal finances will be protected through your limited company. However, as a sole trader, this is not the case. You will be liable to pay damages and compensation from your own pocket.
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To find out more about setting up a limited company online today, please visit Rapid Formations blog, which contains a wealth of information about the company formation process, limited company accounting, annual reporting requirements, and much more. If you have any questions or require assistance, please contact us and we will be happy to help.