Tax Glossary


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Last updated on:
March 17, 2024

A contractor operates distinctly from a traditional employee, typically providing services to clients on a self-employed basis or through an umbrella company. This setup affords contractors a degree of independence in choosing their projects and determining their work terms, distinguishing them from standard employment relationships.

Key Characteristics of Being a Contractor

  • Freedom and Flexibility: Contractors have the autonomy to select their clients and projects, decline work, and set their rates and terms of service.
  • No Traditional Employment Benefits: Unlike employees, contractors are not entitled to holiday pay, sick pay, or other employee benefits, reflecting their independent status.
  • Absence of Employment Contract: While contractors may enter into service agreements, they do not sign employment contracts in the traditional sense.

Tax Responsibilities of Contractors

The tax obligations for contractors vary based on their work arrangement:

  • Through an Umbrella Company: Contractors working under umbrella companies are treated as employees of the agency, with taxes handled through the PAYE (Pay As You Earn) system.
  • Operating a Limited Company: Contractors who work through their own limited companies assume the role of Company Directors, with options to pay themselves via salary, dividends, or a combination of both. Salary payments require adherence to PAYE tax obligations, while dividend payments necessitate filing a Self Assessment tax return and paying any applicable dividend tax.

Understanding IR35 and Its Implications

IR35 is a set of tax regulations designed to combat tax avoidance by individuals working as "disguised employees" — those who function as employees but are taxed as if they were self-employed. The rules aim to ensure that contractors paying taxes outside the PAYE system are genuinely self-employed.

  • IR35 in the Public Sector: Already implemented, IR35 seeks to ensure contractors within the public sector are paying the correct amount of tax.
  • Extension to the Private Sector: Scheduled to expand to the private sector from April 2021, IR35 regulations will scrutinize the employment status of contractors more closely, affecting those considered off-payroll workers.
  • Impact on Genuine Contractors: While IR35 targets disguised employment, genuinely self-employed contractors should not be adversely affected, provided their working arrangements reflect true self-employment.


Contracting offers a unique blend of independence and responsibility, with considerable implications for how work is approached and taxed. Navigating the complexities of contractor status—especially in light of evolving tax regulations like IR35—requires careful consideration and, often, professional advice to ensure compliance and optimize financial outcomes.

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