Self-employed vs Employed: How UK Small Businesses Can Avoid Misclassifying Freelancers and Associates
- kate@thehrhero.co.uk
- 1 day ago
- 14 min read
Most UK small businesses do not set out to break employment law, but misclassifying a “freelancer” who is really a worker or employee can quietly build into a very expensive problem. A clear, robust Contract for Services is one of the simplest ways to protect your business, set expectations and still keep the flexibility and expertise that freelancers bring.
Self-employed vs employed: why UK small businesses need to care
If you run a small business in the UK and rely on freelancers, associates or contractors, the line between “self employed” and “employed” can feel blurry and technical. In reality, it is one of the most important risk areas in your business, because getting it wrong can mean tribunal claims, unexpected tax bills and years of backdated holiday pay or minimum wage.
The key point is this: the law looks at what actually happens in day to day working life, not what you or the freelancer chooses to call the relationship. Even if you have always said “they are just a freelancer” or “they invoice me, so they are self employed”, a tribunal or HMRC may reach a different conclusion based on how things really work on the ground.
What “genuinely self-employed” looks like in practice
Genuinely self-employed people are a separate business in their own right. They typically:
Work with multiple clients, not just you.
Decide how and when they do the work, within agreed outcomes.
Can send a suitably qualified substitute rather than personally doing all the work.
Invoice you for services, rather than being on your payroll.
Provide their own equipment
Employees, by contrast, are under your control regarding what they do, where they do it and when they do it, and you pay them through PAYE with tax and National Insurance deducted Plus access to employment rights like holiday, sick pay and family friendly leave. If someone is integrated into your core team, has a regular pattern of hours and cannot simply decide not to work or send someone else, you are moving into employee or worker territory instead of genuine self employment.
Why freelancer status is so risky for UK SMEs
In the UK, the law looks at the reality of the working relationship, not the label on the invoice. If a “self-employed” person is treated like staff, a tribunal may decide they are actually an employee or worker, with rights to holiday pay, sick pay, minimum wage, pension contributions and more.
Key red flags include:
You control when, where and how they work, just like an employee.
They wear your uniform, use only your equipment and appear to clients as part of your team.
They cannot send a suitable substitute and are expected to personally do the work.
There is an ongoing obligation to offer them work, and an expectation they will accept it.
Two high profile decisions show how costly this can be. In the Addison Lee litigation, hundreds of drivers who had been treated as self-employed contractors successfully argued that they were actually “workers”, unlocking rights such as holiday pay and national minimum wage and leaving the company facing substantial back payments. In the landmark Supreme Court case involving Uber, drivers also won worker status, with the court highlighting the tight control the platform had over pay, terms and how work was done, despite the contracts calling drivers “self-employed partners”.
When these factors stack up, tribunals have repeatedly found that “freelancers” were in fact workers, as in the Pimlico Plumbers case where a plumber gained rights such as holiday pay because the business exerted tight control and integrated him into the core operation. This developing case law is exactly why having a clear Contract for Services that matches how you work day to day is so important.
A quick guide: self-employed vs employed (at a glance)
Here is a simple way to think about the difference in your business:
Self-employed / contractor:
Separate business entity with their own clients and brand.
Decides how and when to do the work, within agreed outcomes.
Can send a suitable substitute.
Invoices you, manages their own tax and NI.
No employee benefits or automatic employment rights.
Employed / on PAYE:
Employed by your business to do a job.
You control what, how, where and when they work.
Paid via PAYE with tax and NI deducted.
Entitled to statutory rights such as holiday pay, sick pay, pension and, for employees, unfair dismissal protection after a qualifying period.
If your “freelancer” looks more like the second list than the first, you have a misclassification risk that a Contract for Services and a rethink of your working practices can help you address.
The third category: “worker” status in the UK
In UK law there is a third category between employee and self-employed called a “worker”. Many of the big headline cases, including Uber and Addison Lee, were about people being found to be workers rather than genuinely self-employed, which still unlocked rights such as holiday pay and national minimum wage.
A person is often classed as a worker if they personally do the work for you, cannot realistically send a substitute and are not truly running their own business with you as just one of several clients. Workers have fewer rights than employees, but more than the self-employed, usually including:
National Minimum Wage.
Paid annual leave.
Protection from discrimination.
Protection for whistleblowing.
They generally do not have rights to unfair dismissal or statutory redundancy pay, which are reserved for employees. For a small business owner, the key takeaway is that even if a tribunal does not go as far as saying someone is an “employee”, getting worker status instead can still create significant back pay and compliance costs if you have treated them as fully self-employed.
The hidden costs of getting it wrong
For UK small businesses, the costs of misclassification are not just legal and financial, they are emotional and reputational too. Financially, you may face:
Backdated holiday pay, potentially over several years.
Arrears of National Minimum Wage where pay fell short.
Employer pension contributions that should have been made.
Legal fees and time spent responding to claims or HMRC enquiries.
There is also the impact on trust and morale if other team members see a freelancer win a case about their status, or if your brand becomes associated with treating people unfairly. Most small business owners care deeply about their team and their reputation, so this situation feels particularly painful as well as expensive.
How a Contract for Services for freelancers protects your business
A Contract for Services sets out the terms of engagement for freelancers or associates, clarifying that they are self-employed and outlining how the working relationship will operate. Done well, it supports the genuine self-employed status by covering things like substitution rights, how they invoice, what equipment they use and how work is allocated.
This brings several big benefits for UK SMEs:
Reduces misclassification risk by aligning the contract with how you actually work together.
Protects you in the event of a dispute, because expectations, deliverables, payment terms and responsibilities are written down.
Helps maintain strong, adult to adult relationships with trusted freelancers by being transparent and fair from day one.
For busy, cash poor founders, a good template saves the cost and time of writing a contract from scratch or paying for a bespoke document every single time you bring in a new associate or consultant.
Key clauses your freelance Contract for Services should cover
If you are working with self-employed contractors in the UK, your Contract for Services should typically address:
Status of the contractor as self-employed, and that they are responsible for their own tax and NI.
Right of substitution, clearly allowing them to send a suitably qualified substitute where appropriate.
Scope of work and deliverables, rather than a job description that looks like an employee role.
How and when they invoice you, and your payment terms.
Use of equipment, branding and uniform, to avoid over integrating them into your core team.
Confidentiality and data protection obligations.
Intellectual property ownership, so you both know who owns what.
Start and end dates for the work to be completed
Termination, notice and what happens if either side wants to end the relationship.
The goal is to reflect a genuine business to business relationship that supports self-employed status, while still protecting your company and your clients.
Sleep at night legal peace of mind for UK business owners
Most owners only realise there is a problem when something goes wrong. A freelancer challenges their status, a relationship breaks down, or HMRC starts asking questions about who is really on the team. At that point, “we thought they were self-employed” is not a defence.
Putting a robust Contract for Services in place gives you:
Confidence that you have addressed core risk areas such as control, substitution and mutual obligations.
A consistent framework you can use for every contractor, so you are not reinventing the wheel or cutting and pasting random clauses from the internet.
Genuine sleep at night legal peace of mind, because you know the basics are covered and your paperwork backs up how you work in practice.
This is especially valuable if you rely on a flexible pool of associates, trainers, consultants or creatives and need to move quickly without sacrificing compliance or fairness.
Protect your UK small business: your next step
If you are relying on freelancers and associates in your UK small business, the most practical step you can take today is to put a robust Contract for Services in place. You do not need to be a legal expert, and you do not need endless calls with a lawyer; you simply need a clear, customisable template designed with small businesses and employment law basics in mind.
Click here to buy your Contract for Services template today: https://www.thehrhero.co.uk/product-page/contract-of-services. This template is designed to help you set up freelancer relationships the right way, protect your business from costly mistakes and give you that all important sleep at night legal peace of mind.
For further reading
FAQ
Q1. How does HMRC define "self employed"?
According to HMRC, you are self-employed if you are in business for yourself, not employed by someone else. Self-employed people typically work for themselves and can choose their own hours and working methods. Key characteristics include:
You decide how, when and where to do your work.
You are responsible for meeting the costs of running your business (equipment, premises, materials, professional fees).
You invoice your clients or customers and are responsible for collecting payment.
You are personally responsible for your own tax and National Insurance contributions.
You can make a loss as well as a profit on your business.
You have multiple clients rather than being tied to one employer.
Q2. How does HMRC define an "employee"?
An employee is a person employed under a contract of employment (either written or implied) to work for an employer. HMRC recognises employees as having a subordinate relationship with their employer where the employer controls what, when, where and how the work is done. Employees:
Are paid through PAYE (Pay As You Earn) with tax and National Insurance contributions deducted by the employer.
Have statutory employment rights including holiday pay, sick pay, pension contributions and family friendly rights.
Cannot send a substitute to do their work.
Work under your control and direction, integrating into your workforce.
Have an expectation of ongoing work and income.
Q3. What is a "worker" according to HMRC?
A worker is someone who has a contract or agreement to do work personally for another person or organisation, but is not an employee. HMRC recognises worker status as a middle ground between self-employed and employed, where someone may invoice but still has limited control over how they work. Workers typically:
Must personally do the work, not send a substitute.
Work under your control and direction, even if they invoice.
Are not genuinely in business for themselves with multiple clients.
Are entitled to some statutory protections including National Minimum Wage, paid annual leave, protection from discrimination and whistleblowing rights.
Are not entitled to unfair dismissal protection or statutory redundancy pay (those are for employees only).
Q4. How does HMRC decide which category someone falls into?
HMRC looks at the reality of the working relationship, not what the contract says. The tests HMRC applies include:
Mutual obligation: Is there an obligation on you to offer work and an obligation on them to accept it?
Control: Who decides when, where and how the work is done?
Personal service: Must they do the work personally, or can they send a substitute?
Integration: Are they integrated into your core business, or are they truly separate?
Financial risk: Do they have financial risk and can they make a profit or loss?
If these factors point more towards employee or worker status, HMRC may challenge a self-employed label, even if that is what the contract says. This is why aligning your contract and your actual working practices is so important.
Q5. What is IR35 and why does it matter?
IR35 is an off-payroll working rule introduced by HMRC to ensure that workers providing services through their own intermediary (such as a limited company) pay broadly the same Income Tax and National Insurance as an employee would.
In simple terms, IR35 targets the practice of people setting up limited companies to avoid employment tax, when in reality they are working like employees. If IR35 applies to someone, their intermediary company must operate PAYE, as if the person were an employee.
Who decides IR35 status?
The rules differ depending on the size of your business and the sector:
Private sector medium and large businesses (more than 50 employees or turnover over £10.2 million): The employer decides IR35 status.
Private sector small businesses (fewer than 50 employees and turnover under £10.2 million): The contractor decides IR35 status.
Public sector: The employer decides IR35 status.
For small business owners relying on freelancers, this means you typically don't have to make the IR35 decision yourself, but you should still be clear about the genuine nature of the working relationship and ensure your Contract for Services reflects reality. If HMRC later challenges the status, having a robust contract that demonstrates genuine self-employment will protect you.
Q6. How can we do performance reviews for our freelancers without making them look like employees?
This is a really important question, because the way you manage freelancers can affect their employment status. The good news is you can absolutely review their work and give feedback, you just need to do it in a way that reflects a genuine business to business relationship rather than an employer to employee one.
Focus on deliverables and outcomes, not how they work
With employees, you might review their attendance, attitude, timekeeping and how they complete tasks. With freelancers, the focus should be on the quality of the work delivered, whether they met deadlines and whether the agreed outcomes were achieved. This keeps things outcome based rather than control based.
Use project reviews, not appraisals
Instead of formal "performance reviews" (which sound very employee like), consider calling them project reviews or contract reviews. These should happen at natural points such as the end of a project, the end of a contract period or before renewing an engagement. You are reviewing the work, not the person.
Things you can measure and discuss
You can absolutely track and discuss:
Quality of work delivered against the brief.
On time delivery and reliability.
Communication and responsiveness.
Whether agreed outcomes were met.
Client or stakeholder feedback on the project.
Things to avoid
To protect genuine self-employed status, avoid:
Setting targets around how they work, their hours or their location.
Putting them through the same appraisal process as employees.
Using employee style language like "line manager", "probation" or "performance improvement plan".
Requiring them to attend regular one to ones as if they were part of your internal team.
Top tip: keep it in the contract
Your Contract for Services can include a clause about quality standards and deliverables, so both sides know what "good" looks like from day one. That way, any feedback conversation is simply about whether the contract terms have been met, which is a normal part of any business-to-business arrangement.
Q7. Whose responsibility is it to prove a freelancer's right to work in the UK?
As the business engaging the freelancer, it is your responsibility to carry out right to work checks before they start working for you. This is a legal requirement under UK immigration law, regardless of whether someone is self-employed, a worker or an employee.
What you need to do
You must check that the person has the legal right to work in the UK by viewing original documents such as:
A valid UK passport.
A visa or work permit.
A certificate of settlement or pre-settled status.
A birth certificate (for UK nationals).
Why this matters for your Contract for Services
Including a clause in your Contract for Services that confirms the freelancer has the right to work in the UK protects you and makes the obligation clear from the start. You should also keep a copy of the documents you have seen, along with notes of the check you carried out and when, in case you are ever asked to prove you did your due diligence.
Penalties for not checking
If you fail to carry out right to work checks or knowingly employ someone who does not have the right to work, you can face significant penalties including fines and, in serious cases, criminal prosecution. This is separate from employment law and applies to all workers, whether self-employed, workers or employees.
Tip for small businesses
Many small business owners assume this is only relevant for employees, but it applies to freelancers too. Build this check into your onboarding process for every new freelancer or contractor, and document it clearly. Your Contract for Services should reference this responsibility so both sides understand where you stand.
Q8. What about referencing our freelancers?
When you are talking about your freelancers, the safest approach is to use language that reflects a business to business relationship, not an employer to employee one.
Here is how I would reference them.
Use terms like:
“Self-employed contractor”
“Independent contractor”
“Freelance associate”
“Consultant”
“Supplier” or “service provider” (in contracts and invoices)
In your Contract for Services and emails, you might say things like:
“This agreement is between [Your Business] and [Freelancer Name], a self-employed contractor providing [service].”
“Our freelance associate will deliver [project] as outlined in the brief.”
“We work with a pool of independent contractors to provide specialist support.”
Try to avoid:
Calling them “staff”, “employee”, “team member” or “line report” in formal documents.
Referring to “salary”, “holiday entitlement” or “sick pay” in relation to them.
Putting them in the same policies or handbooks as employees, unless it is clearly adapted for contractors.
Q9. Do I need to do DBS checks on freelancers?
Whether you need a DBS (Disclosure and Barring Service) check depends on the type of work the freelancer will be doing, not their employment status.
When DBS checks are required
You must carry out a DBS check if the freelancer will be working with:
Children (under 18 years old).
Vulnerable adults (over 18 with care or support needs).
In regulated activity roles (such as teaching, social care, healthcare).
This applies regardless of whether they are an employee, worker or self-employed contractor.
When DBS checks are not required
If your freelancer is providing services that do not involve regulated activity or contact with children or vulnerable adults, you do not need a DBS check. For example, a freelance graphic designer, copywriter, accountant or marketing consultant typically would not need one unless there are other specific reasons.
How to handle it in your Contract for Services
If DBS checks are required for the role, include a clause in your Contract for Services making it clear that:
A DBS check is a condition of engagement.
The freelancer is responsible for paying for the check (or you can agree to cover the cost).
They must disclose any relevant information.
You will keep the certificate securely and in line with DBS data protection rules.
Top tip
Do not assume you need a DBS check just because someone is working for you. Check the specific requirements for the role and the sector. Getting it wrong in either direction (doing unnecessary checks or failing to do required ones) can create problems, so it is worth being clear upfront in your contract.
Q10. Whose responsibility is it to check freelancers are paying their tax?
The short answer is: it is the freelancer's responsibility to pay their own tax and National Insurance, not yours.
What "self-employed" means for tax
When someone is genuinely self-employed, they are responsible for registering with HMRC, completing their own Self-Assessment tax return and paying their Income Tax and National Insurance contributions directly. This is one of the key differences between self-employed and employed status.
What you should do as the business engaging them
You are not responsible for checking whether they have filed their tax return or paid their bill. However, you should:
Clarify status in your Contract for Services: Include a clause stating that the contractor is self-employed and solely responsible for their own tax and National Insurance.
Pay them gross: Pay the agreed fee without deducting tax or NI (unlike employees who are paid via PAYE).
Request invoices: Ask them to invoice you for their services, which supports the self-employed relationship and gives you a clear paper trail.
Keep records: Hold onto copies of invoices and any contracts, in case HMRC ever queries the arrangement.
When it becomes your problem
If HMRC decides that someone you have been treating as self-employed is actually an employee or worker, the tax responsibility can shift back to you. This can mean backdated PAYE, employer National Insurance contributions, interest and penalties. This is exactly why getting the relationship right from the start, and having a robust Contract for Services that matches reality, is so important.
Top tip
You do not need to police your freelancer's tax affairs, but you do need to make sure your working relationship genuinely supports self-employed status. If it does, their tax is their business. If it does not, HMRC may come knocking on your door instead.
Disclaimer: Every reasonable effort is made to make the information accurate and up to date, but no responsibility for its accuracy and correctness, or for any consequences of relying on it, is assumed by the author or publisher. If you are unsure about how this information applies to your specific situation, please seek legal advice.