Picking the Right Hat: Employee or Contractor?

Why Getting Status Right Matters

Imagine hiring someone to help with admin. They work from home, but you set their hours and give them daily tasks. You assume they’re self-employed. Months later, HMRC disagrees. Now you’re on the hook for backdated tax, National Insurance, and maybe more.

Here’s what hangs on employment status:

• Tax: Who handles deductions and contributions?
• Legal protections: Think holiday pay, sick leave, notice periods.
• Control: Can you direct how, when, and where work is done?
• Risk: Misclassification can lead to penalties, audits, or legal claims.

It’s not just about ticking the right boxes. Misclassifying someone can affect their rights and your bottom line. Whether it’s a contractor who should be on payroll or an employee wrongly hired as a freelancer, it creates exposure that many small businesses aren’t prepared for.

Missteps are common. But they’re avoidable—with the right contract, some upfront thinking, and tools designed to guide you through.

Spotting an Employee

Employees have a more fixed role in your business. They’re part of the team, often show up regularly, and usually follow your instructions on how to work.

Here’s what usually gives it away:

• Paid a set wage or salary
• Work scheduled or dictated by the employer
• Use company tools or premises
• Expected to work personally (can’t send someone else)
• Protected by employment rights
• Tax and NI sorted through PAYE

You’ll often see employees working long-term with set responsibilities and little say in how the work gets done. If they’re doing the same work as someone on staff but without the contract, it’s likely an issue.

What you need:

A solid employment contract template. This should outline:

• Duties and working hours
• Pay and benefits
• Termination procedures
• Rights and responsibilities on both sides
• Sick leave and holiday entitlement
• Policies around confidentiality and conduct

Digital Legal Forum’s templates are built for UK businesses, written clearly, and ready to use. They include all the essentials and help small businesses stay compliant without legal headaches.

Spotting a Contractor

Contractors are usually external. They do the job, send an invoice, and move on. But they bring their own rules—and their own risks.

Telltale signs:

• Decide when and how to work
• Often work for multiple clients
• Use their own tools or software
• Can send a substitute to complete work
• No guarantee of continued work
• No sick pay, holiday pay, or other rights

Unlike employees, contractors operate independently and take on business risk themselves. You’re not expected to provide them with equipment or manage their schedule.

What you need:

Use a freelance contract or consulting contract template. It should include:

• Project scope and deliverables
• Payment terms and timing
• Timeline or key milestones
• Ownership of intellectual property (IP)
• Confidentiality and non-disclosure
• Clear note on self-employed status

These contracts help set boundaries and reduce risk for both sides. You can grab one from Digital Legal Forum here. They’re simple to customise and written for UK-based service providers.

At a Glance Comparison

What Happens If You Get It Wrong?

1. HMRC Trouble

If HMRC thinks a ‘contractor’ was really an employee, your business may owe unpaid tax, National Insurance, and penalties. Even if you didn’t mean to misclassify them.

2. Tribunals

If someone feels they were denied proper rights, they may file a claim. That means legal costs and potential compensation. For example, if they weren’t given paid leave or were let go without notice.

3. Muddled Contracts

Using the wrong template leads to unclear expectations and unenforceable clauses. If it goes to court, the actual working relationship will matter more than what the contract says.

To keep things clean, always start with the right type of contract. Then stick to it in practice.

When You’re Not Sure

Status isn’t always black and white. Hybrid work setups, project-based roles, or long-term freelancers can blur the lines. Someone might start as a contractor but become part of the team over time.

When in doubt:

• Ask: who controls the work?
• Look at the whole relationship, not just the contract title
• Consider IR35 rules if working with limited companies
• Track how the work is being done—not just what’s written on paper
• Get advice from a legal support platform like Digital Legal Forum

It’s safer to reassess than to be caught out by an audit or tribunal later.

Quick Tips for Small Business Owners

• Always have a written agreement—verbal contracts are risky
• Use a contract that fits the role: employee or freelancer
• Review contract status regularly as work relationships change
• If someone starts acting like staff, they may be staff
• Don’t rely on job titles—rely on facts
• Keep documentation and evidence of the working relationship
• Use consistent language in contracts and communications

Real World Example

Claire runs a design agency.

She hires Jake, a graphic designer, to help with a rebrand. He works from home, uses his own laptop, invoices monthly, and has other clients. The contract is project-based, and they agreed he can outsource if needed.

→ Contractor.

Later, Claire hires Sam. He works full-time from her office, uses company files and hardware, and gets paid on the 28th each month. She sets his hours, and he only works for her.

→ Employee.

Getting this wrong could mean thousands in backdated PAYE or tribunal claims.

Need Help?

Digital Legal Forum gives you access to:

• Employment contract template UK (ready to go)
• Freelancer and consultant contracts (including substitution and IP clauses)
• Ongoing support from real legal experts
• Compliance guidance for IR35 and HMRC reviews
• Contract audits to help you check your current arrangements

Whether you’re hiring for the first time or restructuring your team, make sure your contracts do what they’re meant to—protect your business.

What’s Next

This is the first post in our contract series.

Up next: a breakdown of benefits and protections in employee and contractor relationships — plus when to seek extra legal advice. [insert link]

Follow the Digital Legal Forum for simple, affordable ways to handle legal essentials. From ready-made contracts to support with compliance, we’re here to help small businesses stay one step ahead.