Hiring contractors compliantly in the United Kingdom
Reviewed by Mellow Editorial Team, HR & payroll content team
Hiring a contractor compliantly in the UK means correctly determining their employment status, setting up the right contractual and tax arrangements, and meeting your ongoing obligations — before they do a single day of work.
Step 1: Determine employment status and IR35
The first question is not whether someone calls themselves a contractor. It is whether HMRC would agree.
IR35 (the off-payroll working rules) requires you to assess whether a contractor working through their own limited company (a Personal Service Company, or PSC) would be an employee if the intermediary did not exist. Since April 2021, medium and large private-sector businesses bear the responsibility for making this determination — not the contractor.
Use HMRC's Check Employment Status for Tax (CEST) tool to assess each engagement. Base your judgement on the real working arrangements: substitution rights, control over how work is done, whether the contractor is financially integrated into your business, and mutuality of obligation. Document your conclusion in a Status Determination Statement (SDS) and give a copy to the contractor and their PSC.
If the engagement falls inside IR35, you must deduct income tax and employee National Insurance from payments and pay employer NI on top. If it falls outside IR35, the contractor's PSC handles its own tax, and your obligations are lighter — though not zero.
Step 2: Classify correctly (and know when someone is actually a worker)
A contractor engaged outside IR35 is still not automatically in the clear from an employment-law standpoint. UK law recognises three categories: employee, worker, and self-employed. Courts and employment tribunals look at facts, not labels.
If HMRC or a tribunal finds the relationship is really one of employment or worker status, you can face back-dated claims for holiday pay (statutory annual leave is 5.6 weeks — 28 days including bank holidays for a five-day week), unpaid pension contributions, and employment rights under the Employment Rights Act 2025, which has strengthened day-one protections. Misclassification is one of the most common and costly HR mistakes a UK business can make.
For genuinely self-employed contractors: they set their own hours, can send a substitute, work for multiple clients, use their own equipment, and bear financial risk. If that does not describe the reality of the engagement, you need to rethink the arrangement.
Step 3: Set up the right contract
Once you are satisfied the engagement is genuinely outside employment, put a written contract in place before work begins. A well-drafted contractor agreement should cover:
- Scope of work and deliverables — specific outputs, not a job description
- Rate and payment terms — fixed fee or day rate, invoicing schedule, payment timeline
- Substitution clause — a genuine right to send a substitute supports outside-IR35 status
- Intellectual property — ensure IP created during the engagement vests in your business
- Confidentiality and data handling — especially relevant where contractors access customer data
- Termination provisions — notice periods or project-based end dates
Avoid language that mirrors an employment contract. Clauses such as "9–5 attendance required" or "subject to annual review" undermine your IR35 position.
Step 4: Handle payments and tax correctly
How you pay a contractor depends on their IR35 status.
Outside IR35: The contractor invoices you. You pay the invoice gross (no deductions). They handle their own income tax and NI through their PSC or Self Assessment. You do not run them through payroll, and you do not auto-enrol them in a pension scheme.
Inside IR35: You (or a third-party fee-payer in your supply chain) must operate PAYE. That means deducting income tax at the appropriate rate (20% basic, 40% higher, 45% additional, above the £12,570 personal allowance) and employee NI at 8% (2% above the upper earnings limit), and paying employer NI at 13.8%. These payments must be reported to HMRC under Real Time Information via a Full Payment Submission on or before each payday.
Sole traders operating without a PSC are always paid gross; they handle their own Self Assessment.
Step 5: Manage ongoing compliance
Compliance does not end once the contract is signed.
Review engagements regularly. Working arrangements can drift. A contractor who starts as genuinely outside IR35 can slide inside it if they begin working exclusively for you, at your premises, under your direct supervision, for an extended period. Reassess status if the nature of the engagement changes materially.
Keep records. Retain your CEST results, SDS documents, contracts, and invoices. HMRC can investigate historic engagements, and clear documentation is your best defence.
Be aware of the 2025 employment law changes. The Employment Rights Act 2025 continues to reshape the landscape for all working relationships. Stay alert to updated guidance on worker classification, as further secondary legislation is expected.
Consider umbrella companies carefully. Some contractors prefer to work through an umbrella company rather than a PSC. If you engage contractors this way, you still need to understand the supply chain and confirm that PAYE is being operated correctly — HMRC can hold the end client liable if an umbrella fails to account for tax properly.
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